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CandleStick Charts
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Trend Recognition Technical analysis and charting in general are built on the assumption that prices trend. These lines are an important tool in technical analysis for both trend identification and for confirmation. Trendlines depict the past movement of a security in an attempt to help predict future price movements. These lines are usually drawn off the bottoms of bars or candles of an advancing move in the stock or index in an up trend, and off the tops of bars or candles in a declining move for a down trend. Sometimes, we will determine trend through the use of moving averages (such as the 21-, 50-, or 200-day moving averages) or through the use of the hourly, daily, or weekly MACD (moving average convergence-divergence). As a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance, many of the principles applicable to trendlines can be applied to support and resistance levels as well, so be sure to read the Support and Resistance section here as well. Down Trendline A down trendline has a negative slope and is formed by connecting two or more high points. The second high must be lower than the first for the line to have a negative slope. Down trendlines act as resistance and indicate that net-supply (supply less demand) is increasing even as the price declines. A declining price combined with increasing supply is very bearish and shows the strong resolve of the sellers. As long as prices remain below the down trendline, the downtrend is considered solid and intact. A break above the down trendline indicates that net-supply is decreasing and a change of trend could be imminent. See Chart 1 below.
Up Trendline
Chart trendlines can be plotted using arithmetic scales or semi0-logarithmic scales. High points and low points appear to line up better for trendlines when prices are displayed using a semi-log scale. You will notice when a log scale is used as the distance between price levels is not spaced evenly, but is increased (or decreased) at an increasing rate. An arithmetic scale displays incremental values (5,10,15,20,25,30) evenly as they move up the y-axis. A $10 movement in price will look the same from $10 to $20 or from $100 to $110. A semi-log scale displays incremental values in percentage terms as they move up the y-axis. A move from $10 to $20 is a 100% gain and would appear to be a much larger than a move from $100 to $110, which is only a 10% gain. Since it takes two or more points to draw a trendline, the more points used to draw the trendline, the more validity attached to the support or resistance level represented by the trendline. It can sometimes be difficult to find more than 2 points from which to construct a trendline. Even though trendlines are an important aspect of technical analysis, it is not always possible to draw trendlines on every price chart. Sometimes the lows or highs just don't match up and it is best not to force the issue. The general rule in technical analysis is that it takes two points to draw a trendline and the third point confirms the validity of the trendline. As the steepness of a trendline increases, the validity
of the support or resistance level decreases. A steep trendline results from a sharp
advance (or decline) over a brief period of time. The angle of a trendline created from
such sharp moves is unlikely to offer a meaningful support or resistance level. Even if
the trendline is formed with three seemingly valid points, attempting to play a trendline
break or use the support and resistance level that has been established will often prove
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