A Few Thoughts About Drawing Trend Lines

I generally like trend lines because of the basic information that they convey - a trend. A trendline going up and to the right suggests the trend is upward! A trend line going down and to the left suggests the trend is downward! You don't need to overthink it. BUT you also have to remember that if you chose to trade a trendline you need to be willing to sit on your hands, be patient, and wait... wait... wait until that trendline comes into any contact whatsoever.

Always 3 or more connecting points!

Before I get deep into trendlines and how I have learned to use them, I want to quickly comment on one art of trendlines that needs to be addressed: a trendline needs to connect at least 3 or more times. Anyone can draw a trendline with two connecting points. You will always find that. What separates a random trendline with no visual significance is one that has 3 more trendlines. Yes it might still be random, but each trendline touch and bounce also may show that someone else is following this exact trendline as well, either from a fundamental mindset (growing revenues with price or something like that) or a technical mindset (trend following, dip buying, etc).

Trendlines are not easy

As Benoit Mandelbrot once said, “The trend has vanished, killed by its own discovery.”

I always think of that quote when setting trendlines, because, well, there is a dual edge sword to when you found the trendline and its time horizon. Are you late to the trendline? Has everyone already discovered this winning investment? Or is only just beginning? Of course, the trend can be reinforcing and the longer it lasts the stronger it can get, but ultimately you want to avoid hype. Find the trend BEFORE the discovery of it by everyone else.

A few other Trendline tips

I think a lot of people will trade trendlines thinking "well it's up, so if I get in here at least I know it's heading up!" But that is the wrong way to think of trendlines. You actually may want to think of it as the opposite.

For example, how far off is price from the trend line you drew? Is it 10% above the trendline or 20% above the trendline? Well that's actually a reason to wait. Let it come to you. You can create an alert right on the Trendline and then sit back, kick your feet up, and patiently wait for that alert to trigger.

So to me a Trendline is not a buy signal or a bullish event. Actually possibly the opposite. It's more of a buy the dip event. Something you wait to be tested and then your risk/reward aligns.

But like I said, one problem I often see with trendlines i people think just because the trend is up now is a good time to buy. No... wait for the trendline test before you think of buying.

Hope you enjoyed this quick post about trendlines and how I think about them!

Comment:

I accidentally included a second chart in this example showing the market cap of Microsoft. But that is also something to keep in mind!

You can analyze trends of fundamental metrics and ratios!

Diversify the data you analyze.