Trendline and Channel Tutorial: Part 2

CBOT:AW1!   Bloomberg Commodity Index Futures
In part 2 we discuss how to construct and utilize sloped trendlines (TL) and Channels in order to better understand the ebb and flow of supply and demand. Like most other charting techniques understanding supply and demand and its relationship to trends and channels depends on you staring at hundreds and thousands of bar charts. Unfortunately, there just isn't a shortcut. It's hard work.

Uptrends represent the "stride of demand." They are a graphic representation of the willingness of the composite investor to enter new longs at consistently higher prices. The parallel channel top is the overbought or supply line. A point in the trend where the composite investor might be reliably expected to reduce their long positions. The median line represents (roughly) the center of the channel. At times (as in the commodities example) the median line may have a basis in the chart pattern, but more generally is simply scribed roughly in the center of the channel. The median line is useful in gauging supply and demand relative to the channel boundaries.

TLs need to be constantly adjusted and often are messy. Most of the time these adjustments occur with a significant lag, but even with the delay the channel helps to define and visualize the aggresiveness or lack thereof of the supply or demand. In the markets that I am most interested in, I constantly adjust the channel elements to best reflect the latest pivots and chart elements.

In my analysis I also use volume, Wyckoff principles and other techncial methods to build the viewpoint. TLs and channels are like any other technical pattern in that they are much stronger and more understandable when combined with multiple methods and tactics.

These patterns are fractal. They occur in all time perspectives from 1 minute to decades and are generally analyzed in the same manner.

Generally Speaking:

-The relationship of the market to the demand line and the supply line relate to the aggresiveness of the demand.

-Ideally a reaction higher from a demand line should cover the entire distance to the supply line. A failure to push to the overbought line (the channel top) is often a sign that the trend is weakening.

-A modest overthrow of a supply line is generally a sign of demand, but if the overthrow occurs late in the trend and represents a significant acceleration, there is potential that it is terminal (see the commodities chart).

-A failure to decline completely back to the supply line is a sign of relative strength.

-How markets relieve overbought conditions within the channel is important. A move to the supply line with an overbought RSI (or momentum oscillator of your choice) that subsequently moves laterally is a bullish show of demand or strength.

-A modest violation of an uptrend would suggest a weakening in the underlying trend while an inability to fully decline to the uptrend would suggest a trend gaining strength.

Bloomberg Commodity Index Daily:

The channel in commodities that has defined trading for most of the last two years displays many of the concepts. Note that like most other TLs and channels the process can be messy. Adjusting demand, supply and median lines as the market evolves takes practice.

-From the pandemic low in late March 2020 commodities began an extended daily/weekly perspective bull market. At the end of September (B) the market formed a pivot that allowed the projection of an initial demand line. It also allowed the projection of an initial supply line from point A.

-As the channel progressed, the markets behavior made it clear that demand was strengthening. Highs were overthrowing the initial projected supply line, reactions from the initial supply line were finding support ABOVE the demand line and when momentum (RSI) became overbought, it was being relieved through mostly lateral to higher prices. All represented strong underlying demand.

-While the initial supply line proved inadequate it did provide a median line to the eventual channel. The median line offered important support or resistance on multiple occasions.

-Soon after point C, a new supply line could be projected.

-From March through September 2021 the market held solidly above the midpoint of the channel. This is clearly a sign of strong demand and bodes well for additional gains.

-After testing the demand line in late 2021, the market once again moved back to the supply line. The easy move higher (no notable counter trend reactions) suggested a lack of sellers. Combined with the prior long lateral move above the midline, it was obvious that buyers were in complete control.

-In February 2022 price exploded above the top of the supply line as the demand that had been evident for months completely overwhelmed the available supply.

-Often a significant overthrow of the supply line is terminal. In this case the market produced a three drives pattern before beginning a steep decline. The break below the pattern trendline is a good example of a type 3 trendline.

In Part 3 we will look at another example (Ten year Treasury yields) and explore using demand and supply lines as a trading vehicle.

And finally, many of the topics and techniques discussed in this post are part of the CMT Associations Chartered Market Technician’s curriculum.

Good Trading:
Stewart Taylor, CMT
Chartered Market Technician
Taylor Financial Communications

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