Posted by forex at 2:53 AM
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1. Use Yahoo! Finance, StockCharts or other free website to draw the historical price chart of a stock over time, which could be minutes, days or years.
2. Mark or number the high and low points. For example, you could number the low points L1, L2 ... and the high points H1, H2 ... for easy reference. Depending on the time scale and volatility, you could see multiple high and low points.
3. Connect the low and high points to draw the trend lines, but do not connect a low point to a high point. Ignore outliers, which are price points significantly higher or lower than the other price points. Markets often have wild one- or two-day swings and then return back to the trend.
4. Determine if the line is an uptrend or a downtrend. The line connecting higher-lows or higher-highs slopes upward and is an uptrend line. The line connecting lower-highs or lower-lows slopes downward and is a downtrend line. Higher-highs and others refer to successive prices that are lower or higher than previous prices.
5. Assess the validity of the trends. A rule of thumb, according to StockCharts, is that you need at least two price points to draw a trend line and a third to confirm the validity. You also can use volume charts to further validate a trend because higher volume indicates higher demand for the stock.
6. Examine the spacing of the price points and the angle of the trend lines. Spacing is directly proportional to the strength of a trend. Regarding angles, the steeper the angle of a trend line, the weaker the trend. This is because a sharp price move up or down is unlikely to offer support to a downtrend or resistance to an uptrend. Support means that demand is strong enough to prevent the price from declining further, and resistance indicates the price level the stock cannot break through.
7. Identify trend reversals. This means an upward price move from a downtrend and a downward price move from an uptrend. Confirm and validate the new trend line as before.
8. Consider using technical indicators for additional insight. A basic indicator is the simple moving average, which is the average price over a specific time interval with new data replacing old data. For example, a 50-day simple moving average is the sum of the closing prices over a 50-day period divided by 50. A rising moving average signals an uptrend while a falling moving average indicates a downtrend. Technical analysts often use short-term (for example, 20-day moving average) and long-term (for example, 200-day moving average) indicator charts to determine uptrends and downtrends.