Tuesday 3 October 2006

Trend Line Bounce

Trend line bounce today.  The Emini closed up at 1,343.25 on Tuesday.  The market gapped down at the open, continued lower and then bounced off a rising trend line.  Keep reading this article to see how I plot trend lines and use them to gauge the mood of the market.

Trend Line Image

No one agrees when it comes to plotting trend lines

Drawing trend lines can be very subjective.  If you asked a dozen market analysts to draw trend lines on a chart, you would probably get a dozen different answers.  The most rigorous approach to drawing trend lines that I’ve seen is in Tom DeMark’s book “The New Science of Technical Analysis.”  His approach is to identify the most recent significant pivot point and then draw the trend line backwards.  This works well and is easy to use.  However, I do object to Tom thinking he can trademark this idea and call it TD Lines!

Let your computer do the hard work

Most market commentaries I've read have hand-drawn trend lines.  I prefer to take a different approach to drawing trend lines and let the computer do the thinking for me.  The trend lines on the chart above have all been drawn automatically.  First, pivot points with a strength of 4 (i.e. higher or lower than the 4 bars on either side) are identified and plotted as red and green dots on the daily bars.  Then trend lines connecting these points are then automatically added.

Rising trend lines are colored green and falling trend lines colored red.  In addition, I also color the daily bars based on the trend line direction; red for up and green for down.  Market indecision is shown with white daily bars. (note: sorry if that coloring convention seems confusing, maybe I’ll change it someday)

Trend lines can be quite significant, however …

The chart above shows an up trending market with today’s low touching the trend line that connects the last two pivot points.  It always surprises me how precisely the market can react to these trend lines - sometimes bouncing off them almost exactly, as we saw today.

In my own trading I like to watch these trend lines to see breaks and bounces.  However, I rarely use them to make decisions about entry or exit points.  I prefer to use indicators of “smart money” activity and exhaustion points.

Do a Google search for trend line to get more information.

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