How to Use Trendlines to Anticipate Market Turns
When I began my career as an analyst, I was lucky enough to have some time with a few old pros. One in particular that I will always remember told me that a kid with a ruler could make a million dollars in the markets. He was talking about trendlines. And I was sold.
I spent nearly three years drawing trendlines and all sorts of geometric shapes on price charts. And you know, that grizzled old trader was only half right. Trendlines are one the most simple and dynamic tools an analyst can employ... but I have yet to make my million dollars, so he was wrong, or at least early, on that point.
Despite being extremely useful, trendlines are often overlooked. I guess itís just human nature to discard the simple in favor of the complicated. (Heaven knows, if they donít understand it, it must work, right?) In chart 1, I have drawn a trendline using two lows that occurred in early August and September of 2003. As you can see, each time prices approached this line, they reversed course and advanced. Sometimes, Soybeans only fell to near this line before turning up. And other times, prices broke through momentarily before resuming the larger uptrend. But what still amazes me is that two seemingly insignificant lows last year pointed the direction of Soybeans ó and identified several potential buying opportunities ó for the next six months.
Besides simply connecting highs and lows, you can draw trendlines in many other ways that are just as exciting and informative. Chart 2 shows a technique I call Primary Angle. Notice the upward trendline drawn in Sugar in late 1999 (A1). Now look at the trendline up from the 2002 low (A2). See anything interesting? These two trendlines are parallel! The slope of the late 1999 rally is the same for the 2002 advance. In fact, the range of the weekly high for the 2002 advance encompasses this line. The same is true for the two downward sloping trendlines drawn off the 2000 and 2003 highs (B1 & B2); the angle of the decline is the same.
Another way to use Primary Angle besides identifying possible trend changes is clear in chart 3.The trendline up from the March low is a parallel of the late February advance. As you can see, prices were falling off of this trendline by the March high. I interpret this as weak price action with waning momentum. And resulting price action supports this conclusion. In chart 4, notice how prices are to the right of the downward trendline from the March high. Again, this selloff lacks the intensity of its predecessor.
You can see in chart 5 why this makes sense from an Elliott perspective. The wave pattern from the March 35.05 peak is an expanded flat correction (3-3-5). Wave (a) bottomed at 31.75 basis May and wave (b) topped at 35.18 (after making a moderate new high beyond the extreme of wave (a).) Wave (c) of 9 is underway targeting Fibonacci support at 30.44-29.63. Itís not surprising to see prices behave like this near the end of a wave pattern.
Chart 6 displays another trendline technique called the Triple Fan. I picked this up from a wonderful book called Timing the Market by Curtis Arnold. I am surprised at how often this tool ushers in significant moves. Down from the September 2003 high in Coffee, three downward sloping trendlines are drawn against peaks 1, 2 and 3; this is your fan. A break of the third trendline often signals a significant move or change in trend, which it did in this case. In December 2003, Coffee gapped above this line and tried to test the top of it before rallying to 80.60!
A similar example is illustrated in chart seven, June Live Cattle. Beginning with a significant extreme, three downward sloping trendlines are drawn across the tops of three following peaks. Clearly, these lines provided important support during the mad cow incident in December and the late selloff in March.
So ó trendlines are a great analytical tool. They work on any time frame and any market. You can draw them vertically (for timing purposes), horizontally (for marking support and resistance) and diagonally (to identify possible turning points).
And a special thanks goes out to that old pro who emphasized the basics and told me about the kid with the ruler, Pete Desario.
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