Stock Market: How To Construct Trendlines Channels And Analysis Of Trend!

Reading The Stock Market Data With Wave Cycles And Setting Up Price Filtering

It’s essential to set up effective price filtering for more efficient entries, exits, and trend identification in stock market trading.

Stock-Market-How-To-Construct-Trendlines-Channels-And-Analysis-Of-Trend


It is crucial to learn to use channels, trendlines, fan lines to track the stock market data. But before we do that we will brush up on our trend definitions and see if there is any scope to alter the trend definitions:

Classification of a Trend According to Dow Theory:

  • Primary or major trends are longer-term and span from months to years
  • Secondary trends or reactions are medium-term and span from weeks to months
  • Minor trends are shorter-term and span from days to weeks

But if you see the below stock market graph, don’t get confused. Because Trend is still intact.

Stock-Market-How-To-Construct-Trendlines-Channels-And-Analysis-Of-Trend

To be honest with you all, the below point and topic may not really bother me when we see it from a strategic point of view. But it will be great if we can just consume the idea of wave cycles and how the stock market data really behaves with that.

Describing Consolidation and Trends via Wave Cycles and Degrees

We may describe any trend or consolidation in terms of wave cycles, which exist at various wave degrees. Below are the terms associated with a wave cycle comprising three degrees:

Higher Wave Cycle (HWC) - highest wave degree relative to the MWC and LWC.

Medium Wave Cycle (MWC) - a subwave of HWC and is of a lower degree than the HWC.

Lower Wave Cycle (LWC) - a subwave of both the HWC and MWC and is at the lowest wave degree.


Stock-Market-How-To-Construct-Trendlines-Channels-And-Analysis-Of-Trend


Points to note down in understanding wave cycles and degrees:


  1. Volatility at one wave degree may not manifest at a higher or lower wave degree.


  1. The MWC and LWC are both subwaves of the HWC and are regarded as wave cycles of lower degrees. It is critical that a trader be able to visualize price cycles on the chart.


  1. Breakouts levels will be different for each wave cycle.


  1. Being aware of the wave degree being traded will allow the trader to size the stop-loss effectively.


  1. When a large wave cycle (or trend) reverses, all the wave cycles of lower degrees reverse in sync with the larger wave cycle. It is at the point of reversal that all sub-waves of the largest wave reverse together. 


  1. It must be noted that waves of higher degrees need not reverse when waves of lower degrees reverse.


Cycle Period and Cycle Amplitude

Please observe the below illustrations thoroughly, it displays the price action movement enclosed within the channels. Imagine the price action as candlestick here.

Stock-Market-How-To-Construct-Trendlines-Channels-And-Analysis-Of-Trend


Left-hand side, candlesticks are getting contracted as candles are moving in an upwards direction which is not good for an uptrend and if we have a buying position in the stock market. It will be counted as a bearish movement. It displays gradually decreasing up and down cycle amplitudes.


Middle section, candlesticks are moving up in an even shape, neither contracting nor expanding. It will be counted as a neutral or bullish stock market trend.


On the right-hand side, we can see that the candles are expanding as they are moving upwards with the amplitude. This is bullish price action.


Stock market beginners need to pay a close attention to these details.


Decreasing Cycle Period


Below illustration is for decreasing periods of price action, you can call it horizontal decrease versus vertical decrease in the case of amplitudes.


Stock-Market-How-To-Construct-Trendlines-Channels-And-Analysis-Of-Trend

Decreasing cycle periods are also an early indication of potential weakness in a trend. In a similar fashion, a gradual reduction in the cycle period during a downtrend is a bullish indication in the stock market.


With this let’s jump on to see our next topic of what is and how to construct a trendline

and channel.


Folks, this is very important information in the stock market because it works. Hence

a part of the strategies of most of the stock market traders/investors.


Trendlines, Channels, and Fan Lines


You can visualize a trendline as upper horizontal lines drawn when we saw amplitude

and cycles enclosed within two horizontal lines.


A trendline is created by projecting a line forward into the future drawn from two

significant inflection points. 


For uptrends, a line is drawn between two significant troughs and projected into the future, whereas for downtrends a line is drawn between two significant peaks and projected into the future.


When drawing trendlines, lines must not cut through any price action at any point

along the line.


Being one of the types of price overlays, trendline act as a price action barrier which means it provides support/resistance to the price action.


In order to draw a valid trendline, you just connect only two troughs of the price action

(see 1 & 2 points in the below illustration) and draw a line further. In the future, the third

point of the price action must be touching the line drawn. 


Stock-Market-How-To-Construct-Trendlines-Channels-And-Analysis-Of-Trend

Trendline Reliability Elements


A reliable trendline may be defined as a trendline that provides consistent support

and resistance to price action.


1. Angle of trendline

A steep uptrend, that is, above 45 degrees, is usually regarded as less stable and may

not be able to sustain itself over the longer term. The most reliable uptrend line is

one where the angle of ascent is approximately 35 to 45 degrees.


2. Duration of trendline

A longer‐term trendline will attract a larger number of buy orders above it and sell

orders below it, and in the process transform into a stronger and more significant

barrier to price. This makes longer‐term trendlines more reliable. 


3. Number of price retests

The greater the number of retests a trendline experiences, the more indicative it is

that traders are aware and paying attention to a trendline. Such a trendline will

normally attract more orders around it.


4. The clarity of the price retests

The more precise the retest, the more indicative it is that the market participants are

aware of such a trendline.


5. Confluence with other indicators

The more convergence there is with other bullish or bearish indicators at the point

of contact on the trendline, the stronger will be the rejection of price at the trendline.


TENTATIVE AND VALID TRENDLINE

 

Strengths


  • Trendlines, being straight lines, will catch any trend changes effectively.
  • Trendlines can identify trends without the need to identify specific price patterns and formations.
  • It is simple to construct and may be applied across all timeframes and markets with equal ease.
  • A trendline is viewable across all timeframes.

 

Weaknesses

  • Trendlines, just like moving averages, are also subject to whipsaws(chart patterns that failed/unable to successfully complete) and are less effective in erratic, volatile, or ranging markets.
  • Consolidation may cause a trendline to be breached at some point in time, in the absence of a legitimate trend reversal in the stock market.

Trendlines that allow breakout in the direction of the existing trend are referred to

as a continuation trendlines.


Trendlines that allow breakout in the opposite direction to the existing trend are

referred to as reversal trendlines.


Possible target range using trendlines at the breakout:


Price Projection- 1:1 BREAKOUT POINT TO DIRECTION WHERE IT

HAPPENED FROM TOP


To forecast the minimum price target for a trendline, simply apply a one‐to‐one

projection of the distance, that price has moved farthest from the trendline from the

breakout point.


See below illustration:

Stock-Market-How-To-Construct-Trendlines-Channels-And-Analysis-Of-Trend


Until and unless the third point of price action touches your drawn trendline in the

future, it won’t be counted as a tested trendline. That means you can not depend on

it for future support/resistance for price action.


CHANNEL CONSTRUCTION


Channels may also be created by projecting a trendline from a significant peak or trough that is parallel to the uptrend or downtrend line in stock market graph. 


For our understanding, we can say it as an opposite horizontal line to the trendline.

Price action enclosed within the channels, see below:


Stock-Market-How-To-Construct-Trendlines-Channels-And-Analysis-Of-Trend

Channels are useful in that they indicate potential:

  • Entry levels
  • Profit‐taking levels
  • Future price
  • Stop-loss levels


Fibonacci Fan Lines

Stock-Market-How-To-Construct-Trendlines-Channels-And-Analysis-Of-Trend

Here is how to construct a Fibonacci fan line:


  • Identify a significant Fibonacci retracement range.(Price range from Peak to Base).
  • Draw a vertical line from the peak of the retracement range to the trough’s price level.
  • Divide the vertical line into 38.2, 50, and 61.8 percent levels.(From Peak)
  • Project three lines from the trough, intercepting the three retracement levels located on the vertical line.

Book Alert:


Trade Like Pro. The Ultimate Trading Kit to Master Supply & Demand: Trade Like Professionals

-BY JODE LEBIN AND KHALID TALAL


KEY TAKEAWAYS

  • Trends via Wave Cycles and Degrees: Higher Wave Cycle (HWC), Medium Wave Cycle (MWC), Lower Wave Cycle (LWC)
  • Cycle periods and amplitudes in waves with respect to price action in the stock market.
  • Alternative definitions of a trend other than Dow Theory in the stock market.
  • Construction of trendlines, channels, and fan lines for entries & exits.


Post a Comment

0 Comments