Uptrends and downtrends are hot topics among technical analysts and traders because each participant wants to ensure that the underlying direction of the trend is working in favor of his or her position rather than against it. Trendlines are the easily recognizable lines that traders draw on charts to connect a series of prices together. The resulting line is used to give the trader a good idea of the direction in which a current position might move.
One of the primary reasons trendlines are so popular is because they can help a trader identify levels on a chart beyond which the price of an asset might have a difficult time moving. Predicting areas where a stock might find resistance can be very useful for traders looking for strategic exit positions and it can also be an effective tool for managing risk. A trendline that will act as a barrier to a move higher, known as a level of resistance, is created by connecting a series of highs. As you'll see below, the slope of the trendline can vary substantially, but the interpretation remains the same. As the price nears a level of resistance, there are two different scenarios that will occur: 1) The price will bounce off the trendline and move lower, or 2) it will move through the trendline, which is usually used to illustrate that the bulls are in control of the direction and is often used as a buy sign.
For more, see Track Stock Prices With Trendlines
In general, an upward sloping trendline that is used by traders to connect a series of highs suggests that the bulls are in control of the long-term direction. However, it also suggests that the short-term upside may be limited. In this case, a nearby trendline usually suggests that the recent rally may be getting overextended and that the asset may be a prime candidate for a pullback.
A horizontal trendline used as resistance suggests that the supply/demand is near equilibrium at this price and that the direction may remain sideways until a stronger signal about the future direction is generated.
Lastly, a descending trendline that is used as resistance generally suggests that the bears are in control of the long-term direction. In this case, a move toward a nearby trendline suggests that the bears may be getting ready to send the stock lower in the short term. Let's take a look at a few trendlines to help put these different scenarios into perspective.
Allstate Corp. (NYSE:ALL) - The strongest form of resistance comes from using a trendline that has a negative slope. The downward bias of the trendline suggests that the bears are in control of the longer-term direction and in this case most traders would expect the downtrend to continue. As you can see from the chart below, the nearby trendline will likely act as a barrier to a move higher. Most analysts will keep a short-term, bearish outlook on Allstate until the price rises above $51.
Avalonbay Communities Inc. (NYSE:AVB) - Taking a look at the daily chart of Avalonbay Communities, you'll notice that the price was unable to move above $106. The short-term horizontal trendline was created by connecting the highs and the bounce off this level suggests that the resistance is stronger than many bulls were anticipating. Friday's close below a short-term ascending trendline (dotted line) suggests that the downward momentum will likely increase and it wouldn't be surprising to see many bulls remain on the sidelines until the price is able to move above $106.
Gilead Sciences Inc. (Nasdaq:GILD) - Gilead Sciences has been in a very impressive uptrend since 2006. However, as you can see from the chart below, the upward momentum seems to run out of steam each time it nears the ascending trendline. A bounce off an ascending trendline, like the one shown in the chart, is not used to suggest that the long-term trend will change directions; it should be interpreted as a cautious sign that the rally may experience a short-term pullback. Some traders may want to protect their profits and look for a more strategic entry if the bears take control. It seems that the short-term upside is capped at the nearby swing high of $54.59 and many bulls may remain on the sidelines until the price is able to move above this level.
For more on trend trading see:
ADX: The Trend Strength Indicator
Find A Trend With The Partial Retrace