Traders face a dizzying number of indicators and methods to help them determine the next move in the markets. You have oscillators, moving averages and Fibonacci retracements just to name a few. Computerized charting software has further expanded the choices available making the average trader’s decision overwhelming. It’s not uncommon for some market participants to use 3, 4 or as many as 10 indicators in an attempt to generate buy and sell signals, leading a fellow trader to remark that “technical analysis” should really be called “technical paralysis.” The fact is, many traders unfortunately miss major market moves because they’re sorting through the mixed signals generated by multiple indicators. Get back to basics when trying to determine market direction. To do that, start with one of the most common charting tools — trendlines!
The first thing most traders will say is “I already know how to draw trendlines.” Ask 10 traders to draw a trendline on a chart, however, and you’ll be surprised by how many variations you’ll see. The most important part of drawing a trendline is to be consistent. Resist the urge to try to “fit” a line to your point of view. A good set of instructions for drawing trendlines correctly comes from Victor Sperandeo (Trader Vic). For an uptrend line, start at the lowest low and draw the trendline to the highest low immediately preceding the highest high, without passing through any price bars along the way. For a down trend, start at the highest high and draw a line to the lowest high immediately preceding the lowest low, again without passing through any price bars along the way. The beauty of this method is that the clearly defined rules take the guesswork out of drawing trendlines on your charts.
“Up and down,” (below) shows the weekly chart of the S&P 500 futures contract, which provides an excellent example of both an uptrend line and a downtrend line. The downtrend in the S&P 500 started in August 2000 and continued until April 2003 when the downtrend was broken. The uptrend then took hold and has continued through the middle of January 2006.
In addition to trendlines, a momentum indicator is helpful in determining the strength of a particular trend. The 14-period Relative Strength Index (RSI), in particular, makes a great companion indicator. If an uptrend is still going strong, the RSI should show a higher reading at the most recent high as compared with the previous high. The opposite is true for a downtrend. In “Highs and lows,” (below) we see the most recent high in early January 2006 has a lower RSI value than the previous high. This sends a warning that the up-move may be in jeopardy and this would be a good place to book profits on existing long positions.
By starting with the basics, traders can get a read on the overall direction of the market, quickly and easily. Using well-drawn trendlines, along with other reliable and easy-to-read indicators, will help any trader make more sound trading decisions.
Mike Zarembski is a futures market analyst and assistant operations manager with Xpresstrade, a Chicago-based, electronic futures and forex broker (www.xpresstrade.com).
