Trendline

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What is a 'Trendline'

A trendline is a line drawn over pivot highs or under pivot lows to show the prevailing direction of price. Trendlines are a visual representation of support and resistance in any timeframe. Trendlines are used to show direction and speed of price, and also describe patterns during periods of price contraction.

BREAKING DOWN 'Trendline'

There are two branches of analysis in stock research: fundamental analysis and technical analysis. Fundamental analysis is used to determine what to buy, while technical analysis is used to determine when to buy it. One of the most important tools used by technical analysts is the trendline.

Fundamental vs. Technical Analysis

The bottom line for companies is profit. A company with growth in earnings and revenues is also likely to have an increase in stock price, which is what fundamental analysts count on. This is because the market likes to assign a value to earnings. This value is represented by the market price, which is what technical analysts and chartists use to analyze the market. Instead of looking at past business performance, technical analysts look for trends in price action. At the foundation of identifying trends is a tool called the trendline. A trendline helps technical analysts determine the current direction in market prices. Technical analysts believe the trend is your friend, and identifying this trend is the first step in the process of making a good trade.

Creating Trendlines

To create a trendline, the analysts must have at least two points on a price chart. Some analysts like to use different timeframes such as one minute or five minutes. Others look at daily charts or weekly charts. Some analysts put aside time altogether, choosing to view trends based on tick intervals rather than intervals of time. What makes trendlines so universal in usage and appeal is they can be used to help identify trends regardless of the time period, timeframe or interval used.

If company A is trading at $35 and moves to $40 in two days and $45 in three days, the analyst has three points to plot on a chart, starting at $35, then moving to $40, and then moving to $45. If the analyst draws a line between all three price points, she has an upward trend. The trendline drawn has a positive slope and is therefore telling the analyst to buy in the direction of the trend. If company A's price goes from $35 to $25, however, the trendline has a negative slope and the analyst should sell in the direction of the trend.