How a trend is developed?
If you're an experienced trader, read on. You'll be surprised at
what you might learn. Maybe you already know how a trend is
developed, but does a trend constitute support or resistance?
Only the "first test" tells the story, but what an important test
that "first test" is. While I often times "label" a support or
resistance "trend" as an area to be looking for "support" or
"resistance" the terms trend and support are two different terms.
Lets take a historical look at the NASDAQ Composite over the past
19 months on a weekly chart, then identify levels of "support".
NASDAQ Composite Index Chart - weekly intervals, last 19 months.
We've marked the above chart with trend lines and certain points
on the chart with the letters A through M. Follow me here on a
step-by-step approach to understanding trend first, and then
support. Lets take a look at short-term upward trend as
signified by the light blue upward trend. The "trend" was put in
place at point (C) and point (D) (remember from geometry that you
need 2-points to draw a line). How long is this trend? Here's
where "experienced" traders in my mind may make an error. If you
began your count at point (C) I might argue that the trend really
doesn't begin until point (D). Why might I argue this point?
Point (D) is where I was able to establish my trend line, and
therefore, as this line relates to technical analysis and
"potential" support (we will talk about support in a minute) this
trend has just been identifies at point (D). From point (D) on I
will be looking to see if this trend is able to act as support.
If I think that this line is as old at point (C), then I may be
under a false impression that this line is longer than it really
is! I may be able to prove my point later in the discussion.
Now, lets stick with this trend line and focus on point (E).
Notice how this index "bounced" briefly at this point? We'd say
this was the "FIRST" successful test of this trend and a level we
could perhaps call support. Why would we call it support? The
trend was tested and it held for that interval (one week).
Notice the interval directly to the right of point (F)? What
happened there? Support was broken! For those counting, point
(F) was at 4,355.
Dark Blue Upward Trend
Once our "light blue" trend was broken we may have begun our work
on some type new trend to place on this chart. Using the same
discipline as above couldn't we have developed our "dark blue"
upward trend? This could have been put in place using points (B)
and (C). How long is this trend? I would say this trend's
length would start at point (C). Now, lets look focus on point
(G) for a moment. Wasn't point (G) the "first test" of this
trend? I'd say yes, and while the trend failed for a partial
interval, this index "bounced" considerably soon after. Haven't
we been saying, "the longer the trend the more powerful it can
be"? If you agree that the "dark blue" trend began after point
(C) and you counted the intervals after that point, you'd come up
with a 31-week long trend at point (G). In terms of "length of
trend" we might say that the "dark blue" trend is/was longer than
the "light blue" trend and we wouldn't be that surprised that the
"dark blue" trend provided more of a bounce at that point. Did
anyone question where this index eventually hit its next highest
rally? If you did, the answer is 4,259. Isn't this pretty close
to where our "light blue" trend was broken at 4,355. Support
broken becoming resistance? Makes one think doesn't it?
Bright Green Trend
Now we can take what we've learned from the "light blue" and
"dark blue" trends and put it to the test. Points (G) and (H)
establish this upward trend. Much like the "light blue" trend
experience, this trend tried to act as support when it was
tested, but the trend wasn't very long (from point H) and quickly
failed as any type of support. Look what happened soon after to
our "dark blue" trend! It was broken too. Ouch! Two trends
broken within a 3-week period!
Same Chart as above - NASDAQ Composite - Weekly interval.
Bright Pink Trend
This trend "bright pink" was put in place from point (A) and (B).
If you believe the length of this trend now starts at (B) you'll
note the "first test" occurred at point (J). Notice how this
trend held up better than the "light blue" and "bright green"
trends? At point (L) this trend no longer was able to provide
support and another level of trend was broken. That's four
upward trends that have now been broken. What about downward
trends?
Thick Black
The same principles used in upward trends are used in downward
trends. Point (E) to (I) defines our "long-term" downward trend.
If we were counting how long this downward trend is, we might say
16 weeks (if we counted from point I). This trend has not yet
been tested.
Thick Red
If we say that the "thick black" trend is our long-term downward
trend, then by definition, the "thick red" could be called our
"intermediate-term" downward trend. We'd say that points (I) and
(K) define the trend, but point (M) was a test of resistance that
proved to be successful. Until this trend is broken to the
upside, shouldn't we be somewhat cautious for stocks we trade
bullishly in on this index?
How you can use this every day you trade
Now, imagine for a moment the above chart was charted on a daily,
60-minute or even 10-minute timeframes. Can't we use the exact
same principles for drawing trends and establishing potential
support levels on a shorter-term timeframes? There's no way I'd
trade off a weekly time frame, but it serves an excellent purpose
for understanding what type of trend we're in on a longer-term
time frame. If the trend is your friend, have you been trading
the trend? If your answer is yes, then you've been trading the
trend on 10-minute time frames where the NASDAQ composite is
concerned. If that's the timeframe you're trading then you at
least understand that longer-term, four upward trends have been
broken to the downside, and the shortest-term DOWNWARD trend has
stayed intact. Eventually, just as the upward trends were
broken, the downward trends will be broken too. We'll remind
readers that "trend" is just one tool we use to navigate the
markets, but it's an important concept to understand. The trend
is your friend, be willing to trade it when appropriate!
