Trend Channels

In addition to trend lines, analysts work with trend channels, which indicate where resistance might develop during an uptrend or support might develop during a downtrend. Constructing an uptrend channel consists of first drawing an uptrend line, then drawing a line parallel to it, starting from a significant price peak at the beginning of a trend. Downtrend channels are constructed in just the opposite way (Example 3.8).

Once the trend channel is constructed, chartists project levels of possible support and resistance as the trend progresses. In practice, the upper, or resistance, side of an uptrend channel isn't as reliable as the support side of the channel, i.e., the trend line itself. (The opposite is true for a downtrend channel.) However, chartists can
combine trend channels with character-of-market indicators (e.g. overbought/oversold or momentum indicators) to get a better idea of whether a market is ready to reverse direction when it reaches one side of the trend channel or the other (Example 3.8).

Trend Adjustments

The various combinations of highs and lows within a trend that a chartist can use to construct trend lines and trend channels can be confusing. Experience helps, but most technical analysts draw one or more "competing" trend lines or channels, hoping that the market will eventually conform to just one of them (Example 3.9).

As a rule of thumb, a trend isn't considered broken unless the trend line is violated on a closing basis. Some analysts wait for two closes just to be sure, or require that a previous major support or resistance level be violated to further confirm a change in trend. From a trading standpoint, however, waiting that long for confirmation often means the market has already made a big move before a buy or sell signal is given.
Confirmation that the trend has ended can also come from a test of the breakout point. For example, after the violation of an up-trend line (i.e., the market suffers a breakdown, moving below the up-trend line) prices often rally back to the breakdown point, then fail, moving lower once again and confirming that the up trend is over
(Example 3.10).

Characters of Market Indicators

Characters of market indicators help analysts identify the "condition of market" they are observing, such as whether it may be "overbought" or "oversold" relative to some predetermined benchmark. Other characters of market indicators measure the momentum of a price trend. Is it accelerating or slowing? Is price volatility increasing or decreasing? Some of these technical measures don't use price data at all. These include bullish consensus, which measures the level of bullishness or bearishness, and analytical techniques using volume and open interest.

Characters of Market Indicators

Besides trend indicators, characters of market indicators are another popular way of organizing price data. The three most common characters of market indicators are the relative strength index (RSI), momentum indexes or oscillators, and stochastic. Each of these indicators is designed to measure somewhat less obvious qualities of a market, such as whether it might be "overbought" or "oversold" (i.e., too high or low, relative to previous action), or whether price momentum is accelerating, slowing or changing direction. Although analysts can use these types of indicators solely to forecast market direction and formulate trading strategy, they more typically use them in conjunction with other kinds of chart or trend analysis (Example 2.10).

Video: High Probability Setups using Median Lines file