I got the following SUBSCRIBER E-MAIL with a quite good question about how the heck I draw my trendlines:
"When you are drawing your channel lines, what are you choosing as line points? You don't seem to be using exact high or lows, nor closing levels. I'm just trying to understand how you are picking those particular points."
While I have explained a number of times over the years how I draw trendlines, as well as the relative usefulness of trendlines in determining the trend, support and resistance, there is always a time to refresh this information; like NOW!
Our OIN Subscriber also sent me the example of the QQQQ daily chart where I had drawn up and down trendlines, from my weekend Index Trader column; which is the last chart in the article that can be seen online by clicking here.
I need to note the source chart by the LINK above as the one I present below is the SAME chart as referred in the question, but 3 more trading days have gone by PLUS I took out all but the trendline markings AND added an alternative trendline 'C' for comparison to trendline 'B', as seen below in the Nasdaq 100 Tracking stock (QQQQ).
I should say that the two trendlines seen below are NOT 'channel' lines. Channel lines ALWAYS slope in the SAME direction and are PARALLEL lines. You will see me draw trendlines that both slope int he SAME direction but are NOT parallel lines; most often this is a triangle pattern as I'll show later on.
I have in the chart below a down trendline at top and up trendlines below the price action. BOTH are examples of the way that I construct trendlines. However, trendline A and B are also examples of 'internal' (A) or what I call 'best fit' trendlines, especially trendline (B).
An INTERNAL trendline connects the MOST number of highs or lows that are the extremes seen during intraday periods (e.g., hourly charts), during the day, during the week, etc. I don't usually take account of points that represents closing prices; sometimes if the Close is very close to the High or Low and the Close completes a 'best fit' trendline.
For the above chart, the down sloping trendline (A) connects 4 intraday highs and therefore is the most number of highs that I could use in an internal trendline and it CUTS THROUGH or bisects some daily 'bars'. You also note that this trendline is very close to the 'line' of declining highs.
A trendline shows us the predominate trend direction and ANGLE of (trend) ascent or decent. 'Predominate' is the key word and which is why I have found over the years that internal trendlines 'work' the best.
QQQQ up trendline 'B' above only connected 2 intraday lows until TODAY'S (making 3 for now), but you can also see that the angle of ascent represented by this line defined the general area where support was being found on pullbacks. That's what I go for in a 'best fit' trendline. I try to connect 3 or more intraday highs or lows always however. It's interesting to note that today's pullback low in the Q's also touched internal up trendline B. We'll see what tomorrow brings!
Trendline 'C' above is an example of a conventional trendline, which is an 'external' trendline always, in that it is a straight line that connects 2 or more highs or lows and does NOT cut through or bisect a line. I sometimes call a trendline connecting only 2 highs or 2 lows, a 'tentative' trendline, but one connecting 3 or more points is a trendline. If tomorrow or succeeding days' lows touch THIS trendline, then that is the one that will start to connect the MOST number of lows.
I call all of the above simply trendlines, but the trendlines I usually, not necessarily always draw, are internal trendlines as they connect the most number of highs or lows, therefore often cutting through one or more bars (on bar charts; or the thin 'shadow' high or low on candlestick charts).
the chart of the underlying QQQQ Index, the Nasdaq 100 (NDX) has a slight variation of its trendlines, but is basically the same. I constructed an upper trendline connecting the bulk of the intraday highs (internal down trendline). The up trendline I was working with until recently was the GREEN (internal) up trendline, which connected the most number of lows. This trendline then got pierced at seen, and noted, below. The last low around 1680 then was a 3rd point of a (conventional) trendline that suggests NDX support might be found in the area of the green up arrow.
It's interesting to note in the NDX chart above that after the internal up trendline, representing the predominate rate of price change going up (ascent), was pierced, that the last rally failed around 1720 (a lower up swing high) and today saw a healthy decline. At any rate my 'new' trendline is the blue up trendline and it happens to be the trendline that connects the very bottom of all downswing lows TO DATE. Stay tuned for tomorrow and tomorrow after that!
The Nasdaq Composite (COMP) WEEKLY chart is an interesting example of two UP sloping trendlines that outline a rising 'triangle' type pattern, which also looks quite a bit like a bearish rising 'wedge' formation.
There are 5 points that define or are used to draw the upper trendline and this trendline cuts through the price range of two different weekly bars. Still, a very well 'defined' trendline showing the rising resistance, although the 'resistance' suggested by a rising trendline is MINOR resistance. After all, the trend is still going up; which is defined by a series of higher highs and higher (downswing) lows.
The lower up trendline on the COMP chart above is the MAIN or primary up trendline. What defines an uptrend is the line formed by a rising series of pullback LOWS. Where the symmetrical triangle like the one above gets interesting is if or when the LOWER trendline is violated, which is then suggestive of a significant or major top; this would be 'confirmed' by a lower low than the last swing bottom CLOSING weekly low (at 2065 in the case of the COMP Index).
As an example of an uptrend CHANNEL, the Dow 30 (INDU) chart is shown below. The resistance suggested by the touch today that was finally made at the upper channel line has to considered of possible greater importance than the minor resistance suggested by a rising trendline connecting the various rising highs on the way up.
DEFINITION: TREND CHANNELS
A parallel line to this line is then drawn that connects ONE or more extreme highs or extreme lows from a prior period. In the case of an uptrend channel seen in the INDU daily chart below, the one highest high that was used to 'anchor' an upper line PARALLEL to the (lower) up trendline goes back to November. And, guess what, INDU advanced all the way to reach this upper channel line TODAY!
What now? There is nothing to suggest that the Dow won't break through and above this upper trend channel line. However, in surprising number of instances, an upper channel line like this will prove to be at least temporary resistance or represent a period when the rate of ascent or price increase will SLOW significantly.
Prices often tend to just follow the upper line higher in a slower rate of ascent or price change, but not break out above this line; especially when an Index like this one is now at an 'overbought' extreme. At some point after prices reach the upper end of an uptrend channel like shown above in the INDU chart, prices will tend to reverse lower and head back more toward the middle of its channel.
The S&P 500 (SPX) daily chart below shows the projected current upper boundary of its uptrend channel PLUS an uppermost extreme channel line (in gray) that would represent a similar pattern to the Dow.
However, if there was ever a "solitary walk of the Dow" this may be it and making me doubt that the broader blue chip index (SPX) will have the same power move up to the upper end of ITS broadest possible uptrend channel and follow the Dow pattern in this respect.
** Good Trading Success! **