Sunday, March 11, 2012

Why Trendlines Make Healthy Trading

Trendlines are the simplest of all technical analysis but yet the most often ignored by novice traders. Truth to be told, whenever I am analysing a stock, my attention is first fixated onto the MACD and the RSI. Probably these are in colour fills and they grad attention far easier than trendlines that require one to manually draw onto a pool of black and white blobs. Nonetheless, I am constantly reminding myself that trendlines are what makes a trade tick. Obey them.

To illustrate my point, let me refer to the current weekly charts of First Resources and Gallant for a deeper appreciation to the trendlines that I am talking about. I have chosen these 2 stocks just for ease of discussion and that the trendlines have been going on and on since 2009. Surprised? Let's delve deeper.

First Resources has a diagonally up-sloped uptrend for the last 2 years and the trend is still firmly in tact. What is more surprising is that the stock obeys its boundaries very closely, only breaking down in the 2011 sell down and re-entering the region sometime in December last year. That coincided with the soon to come bullish uptrend in the last 2 months. Look where it is now. Firmly sitting/resisted by the mid-trendline (I would like to name it this given it like the 50% fib retracement level).

Of course, the next question is where will this stock head? Right now it is still undecided obviously from its persistence along the mid-trendline for 3-4 weeks but still slightly trending upwards. A bullish break into the upper half of the trend region is possible. However, from the MACD, there is some negative divergence to its histogram (the difference between the signal and its avg) and the signal line. RSI is also strongly in the overbought region. These 2 indicators are clearly suggesting a pull back to come. 2 v 1, you decide.

My point here is not to predict the future trend of this stock price - I have promised myself to only trade when it breaks clearly instead of its slight indecision now - but rather the simplicity of this trade. Anytime along this uptrend, you would have made money some how or rather given its clear clear uptrend. Plus, here comes the punchline, it really has been obeying its boundaries. It is not a science nor an art but it simply obeys its boundaries! So what do you do? Just buy low sell high!

Gallant is an illustration of a sideways trending stock that is perhaps much much harder to trade and to book profits since there is no up/downtrend to support price divergence created by volatility (swings in price action). It takes another approach as horizontal trendlines are used to encapsulate the trending region of the stock price.

Again, if one observes the chart, the stock has been relatively trading in that narrow band, breaking out in end Dec 2011 and breakdown down in May 2010. Otherwise, it has been quite within its boundaries. However, upon closer inspection, it is clear that a sideways trending stock is never that easy to trade, plus this stock does not have much strong up and downs within its boundaries. For example, from Feb to Oct 2010, it simply refused to leave the lower half of the region. In our trader's sense, it does not oscillate and putting a long position when it bounced off the lower trendline may not book one really good profits.

This week, the stock is seen plunging from its highs in Jan/Feb 2012, with prices hitting the trendline and then returning. Using a fib retracement, the stock has just touched the 61.8% retracement and is heading further down, confirmed by the MACD direction and RSI trending down over the last 3 weeks. A really good opportunity to open trades and earn a quick buck. A further check on its daily chart (not shown here) shows very strong MACD downtrend with red histograms. The downtrend is almost further confirmed. However, I would like to caution that this trade needs to be fast as the fib is already 61.7% to 78.6% region and resolute booking of profits early is absolutely necessary in case the stock rebounces.

Having said so much, my point here is not to share some stock tips nor suggestions of stocks to buy but a quick lesson on trendlines and how they can be used to enhance trades. Perhaps my daily trendlines usage is not well refined enough as I prefer to start from weekly. You may have have your own preferences. Whatever it is, never ignore trendlines before you book in that trade. Remember.

Healthy Trading.

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