Gauging the Strength of Trendlines on SPX, Dollar, Oil and GBP/USD
- Trendlines are one of the most simplistic analysis techniques, but they can also be one of the most profound
- I look for three or more points of test, look for influence rather than 'prettiness' and utilize other filters
- We consider the profoundness and strategy that trendlines contribute to trading using the S&P 500, Oil and Dollar
See how retail traders are positioning in the majors using the DailyFX SSI readings on the sentiment page.
Trendlines are arguably one of the most basic but important elements of technical analysis that traders have at their disposable. And yet, they also tend to draw some of the greatest debate. What constitutes an official trendline? Which lines carry more weight than others? What is the sway that this technical chart technique practically holds over the speculative rank? There is no single or 'correct' answer to any of these questions. Much of it is in the eye of the beholder and generates influence as the result of an aggregate outcome of many traders taking position. Nevertheless, we discuss some of the qualities and considerations that are most important for me when applying this crucial analysis tool.
First and foremost, what justifies an official - much less a superior - trendline? Any two points in space (time and price) can be connected to create a line. That is too low a qualifier. Therefore, a minimum of three confirmed points of test make for a more established line. The more points of contact, the more robust a trendline is. This brings about a further consideration as to whether there is some unseen force in the market that gives that movable boundary credibility or whether it is simply self-fulfilling prophecy? As humans, we have an innate sense for pattern recognition. The more obvious the trendline, the more traders there are likely to respond to it thereby giving it credibility. For many, this is reason enough to look for the 'prettiest' of levels. Yet, the discrepancy in particular for lines (tails versus bodies, high time frame levels versus low, etc) can give us an unreasonable degree of confidence in a market that deserves skepticism.
We look to test some of the aspects of what makes a verifiable and meaningful trendline on key markets. For the S&P 500, a multi-point trendline that carried the benchmark index since the aftermath of the US election fell to start this week. Yet, despite a clear break of the rising boundary, the market stabilized and recovered Tuesday. This is evidence that precision in trendlines is not always ideal as it obfuscates the influence of other analytical considerations - technical aspects, fundamentals etc. For crude, there are two prominent trendline supports that seem to be drawn from the past year-and-a-half. One calls a critical bearish break for the commodity while the other shows support still in place. The former only had two points, the latter at least four. Further the Dollar took out a horizontal support in a head-and-shoulders neckline and GBP/USD showed preference for high time frame technicals to turn back shorter gauge measures. We discuss the critical considerations of employing trendlines in today's Strategy Video.
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