One key analysis I do weekly is to check how I've drawn my trendlines on stock and Index charts. Trendlines require frequent adjustment and it probably drives some traders to distraction or not to bother.

I get the impression quite often and most recently from a Subscriber e-mail that traders not versed in using trendlines may figure that frequent adjustment of trendlines is not worth it or maybe not understood as to HOW to adjust trendlines and WHY you would want to do that.

Before I get into the subject at hand, I'll just note, ahead of more tomorrow in my usual Saturday Index Wrap, that:

THE S&P CLEARED KEY RESISTANCE AT 1850

I'm not telling you anything you don't know if I note that the S&P 500 (SPX) has been lagging the Nasdaq in making a new high for the current move. There is a clear cut line of resistance in the 1850 area as highlighted by the horizontal trendline or 'level line' seen below. Repeated moves to the same area in SPX have been turned back by selling and buyers retreating so to speak. Earlier in this past week there was a fairly strong intraday move above 1850, but by the Close, the 'moment of truth', the Index closed BELOW this pivotal resistance. And, today (Friday) also constituting the weekly close adds importance to this particular daily Close.

Also, adding meaning to the aforementioned Close in SPX above 1850 and what in chart analysis terms continues a strong bullish chart pattern, is the fact that my bullish sentiment indicator showed a dip in bullishness today as shown in the bottom-most indicator (CPRATIO) on the SPX daily chart below. It's something I'll pick up on more tomorrow, but the combination of 1.)piercing an important line of resistance accompanied with 2.) LESS trader bullishness is a favored pattern of mine suggesting to bet on MORE upside. But, I digress and want to look at constructing trendlines!

I've got a trendline above on the S&P chart and I might as well start with it. I've redrawn this trendline a number of times and one possible interpretation of SPX's up trendline is seen. (More on that later.) Along with the fact that the PRIOR low or two lows in this case occurring PRIOR to SPX's most recent low, do not TOUCH this supposed up trendline on my chart may make you wonder as to the construction of it and where the 'anchor' of the trendline is back off the chart.

To explain how I arrived at the above up trendline that doesn't connect MOST of the lows I see on this chart takes me down a road of how what I do now with trendlines is contrary to what I learned in charting-101 so to speak; or, what my friend drew on the back of a cocktail napkin in Wall Street days! -:) I have to go back to the start of the current advance. Yes, the current trend had a start and it will have a middle and end too. Not now for that! I can go back to 2011 as start and prior trendline.

STROLLING DOWN MEMORY LANE: MID-JULY, 2011

Back then, per the end-date on below SPX chart which was mid-July 2011, SPX was showing a strongly bullish chart and a projected steep up trendline. SPX's move from 1050 to 1350 was an impressive advance of nearly 20%. An Initial Up Trendline was showing a steep rate of gain that SPX didn't maintain for a time.

The initial run up to 1350, followed by a subsequent 'snap back' rally, was then followed by a sharp dip and apparent (downside) reversal suggesting a good possibility of a double top. Stubborn resistance was also implied by a return to the area of the prior up trendline. What WAS support (at the trendline) had 'become' resistance later on. Support, once breached, or resistance, once pierced, will tend to become the opposite force.

See what comes a year later; or, moving ON! Next ...

AS OF FEBRUARY, 2012

After hitting resistance just over 1350 a subsequent second time, there was a sharp and steep decline that followed. When a low was finally made at Point '1', an intraday dip below 1100, there was of course a pronounced rebound. And, as soon as there's a strong initial rally that retraces more than half of the prior downswing, a corrective dip follows to the low at Point 2.

The pullback low at Point 'sets up' a test of the uptrend as signifying technical support, at the reaction low at Point '3'. Within a day or two, obvious to a chart savvy trader, its time to add to bullish positions or to do so if not in. A 150 point gain occurred after the highlighted dip back to the up trendline noted at '3'. I like it.

FAST FORWARD TO MARCH, 2013:

Resistance came into play once 1400 was breached as seen in my next chart below. The reaction low was followed by a strong rally and drawing a trendline through the first 2, then 3, lows is seen in Trendline '1' or "T1". Once this trendline was pierced there was a pullback to 1350, a fairly 'nominal' retracement and becomes the starting point of yet another trendline, 'T3'.

A 3rd low, if it had been AT the (T3) up trendline highlighted at the green up arrow below, would also have been a dip to expected support at the line of prior highs; what would now be expected support. The Low in the 1475 area, within proximity of intersection of SPX's up trendline, and above expected support, suggested a continued strong bullish trend.

The bull Market we're in took off on an accelerated advance from mid-November of 2012. The dip into June 2013 is highlighted as Point '1' on my next SPX chart as we move forward to the present. Lows at Points '1' and '2' established an initial up trendline of a PARTICULAR TYPE; an internal or what I sometimes call a 'best fit' trendline. An internal up (or down) trendline is one that connects the MOST number of lows; or, highs in the case of an internal down trendline.

Trading-strategy wise, it became advisable to add to bullish options positions at Point '3' and again, at Point '4'. A very smart technical analyst and trader, Jack Schwager, who I worked closely with, used to say that he didn't "believe" in trendlines, rather he "believed in internal trendlines. Point taken Jack!

CONVENTIONAL OR 'EXTERNAL' TRENDLINES:

There is a 'conventional' way used for decades to construct trendlines. We can call this an 'external' trendline. One that uses ONLY the 2 or more lowest lows, or highest highs, to construct a trendline; e.g., per Tom DeMark's trendline tool. This type of trendline is the one that was seen on my FIRST chart above. The trendline 'type' I was using for simplicity sake and which shows the dominant multiyear uptrend quite well.


GOOD TRADING SUCCESS!