Simple is best when trading the market. Most traders get fooled by that idea and think a good method needs to be complicated to make profits. Not from my experience. Simple doesn’t mean ineffective. This easy, yet effective technical tool will keep you in good trades and show you when to exit the losing stock market trades.
Correctly drawn trend lines are a simple, yet very effective tool. This drawing method is different from most you’ve seen, but it is a superior technique. It helps keep long trades profitable by keeping you in the trade. It will alert you to a possible exit before a move down, and it will show you the beginning of a new uptrend.
Properly drawing trend lines is one of the most valuable skills you can learn. Here’s how to do it – let’s start with an up trend and draw the line.
First you need to find three important data points – the lowest low before the new uptrend, the highest high that ended the up move, and the last low before the final high. Draw your line up from the lowest low making sure you touch the last low before the last high. Continue the line past the final high.
To draw a down trend line do the opposite – find the highest high of the trend, find the lowest low, and the last high before the last low. Draw straight down making sure your line touches the last high before the low. Continue the line past the final high.
Try this technique on a variety of charts and you’ll soon see how it can alert you to an important trend change. For example, open a weekly chart of the NASDAQ Composite and shrink your data so the October 2008 through January 2010 price bars fill the screen.
Do you see the lowest low? Hint – it wasn’t in November 2008.
Do you see the last high before the last low?
The trend line starts at the March 2009 low. The final high, before the trend changed, was January 2010. The lowest low before the final high was in November 2009. Draw the line up and touch the lowest low of November 6, 2009. Continue it past the January 2010 high.
Do you see how this line waved the red flag warning that a trend change was occurring? Prices fell sharply once the trend line was broken to the downside. Switch your chart from a weekly to a daily and you’ll see the evidence.
Keeping trend lines current is wise. You might need to readjust them as time progresses as a lower low or higher high will probably occur.
Market moves can be sudden and swift, but being prepared can prevent losing all your profits, poor decision-making, and knee-jerk reactions.
This technique is valid on all time frames. Try keeping trend lines on a couple of different time frames. A break of the higher time frame’s line is the most important. If you trade from a 5 minute chart draw a line there, but on a 10 or 15 minute chart as well. Daily chart traders should keep lines current on a weekly chart.
Remember, you don’t need to know a lot of trading techniques to make money in the stock market, but you must know a few techniques very well.