Stock trend lines are more art than science. It would be a mistake to think of them as an algebraic formula, that if you only understood what they meant, you could plug them into an equation and reach a definitive answer for whether to buy or sell stocks. Different analysts have different ways of drawing trend lines – not to mention interpreting them. Trend lines are drawn to help spot patterns in the fluid movement of stock valuation and highlight where changes in stock price have taken place. This information acts as just another tool in your toolbox for anticipating where a stock is headed and helping you figure out whether to take a chance and grab a piece of that company to add to your portfolio.
Where Trend Lines Come From
A stock chart is a graph with increments of time making up the lateral x-axis (the base) and increments in price making up the vertical y-axis. The price of a stock is then plotted on the graph. When you connect all the dots, you typically see a jagged line that is generally moving up across the graph (increasing in value), down (losing value) or sideways (holding its value). Trend lines set the parameters of those daily fluctuations in price over time. They don’t connect all the dots; they connect two or more of the lowest ones moving in an upward direction (when plotting an uptrend) or two or more of the highest ones moving downward (when plotting a downtrend).
Change In Trend
Minor price fluctuations can occur without constituting a change in trend. A stock in an upward trend is said to "run into resistance" if the stock price points fall on or very near the trend line over a period of time and then begins to move laterally across the graph.
There are basically four stages that a stock can go through in a cycle. Stage 1 occurs after a prolonged downtrend when the graph is moving in a lateral direction. Stage 2 is when a stock comes out of Stage 1 and begins an uptrend, also called a “rally.” Stage 3 is when the graph breaks from a prolonged uptrend and turns to move laterally across the graph -- also called “channeling." The peaks in a channel make up the ceiling, or “line of resistance,” and the troughs of a channel make up the floor, or “support.” Stage 4 is when the stock moves into a downtrend.
Interpreting Trend Lines
Nothing is certain in the stock market. It does not follow that every time a stock’s price flattens out after an uptrend that it will then go into a free-fall, or that a stock will flatten before falling, or that even if it drops suddenly, it won’t shoot up again. Generally, the steeper the trend line, the more unreliable it is as an indicator. Also, when a stock price falls below the support line of a channel, it can be seen as an indicator to sell. When a stock’s price repeatedly breaks through the trend line, but is still moving in the same general direction, one technique is to draw a second trend line connecting the new outliers to see if the trend looks like it is heading for a break or heading into a channel.
Lisa Dorward was a corporate financial executive and business consultant for more than 15 years before becoming a writer in 2003. She has B.A. degrees in both history and creative writing and earned her M.F.A. in creative writing in 2008, specializing in novel-length historical fiction.