Friday, December 5, 2008

Readjusting trend lines

Drawing a trend line is just like connecting the dots. By drawing a line at the highs of a stock you get a resistance level. By drawing a line at the lows of a stock you get a support level.

The theory is that stocks will bounce up from support and bounce down from resistance. Also when a stock breaks a trend line is it likely to stock will have a big run in the same direction it broke.

Drawing a trend line and using them to trade is much more of an art then a science. As such they may need to be constantly readjusted as stocks take on new behaviors. Stocks may break above levels of resistance only for a short time then fall all the way back to support.

In which case, it is better to take the new high into consideration when redrawing your resistance level. Another example would be in an up trending stock, where the stock has just made a fast rally which leaves all your trend lines in the dust and makes them obsolete. In which case, your trend line will have to be drawn again to incorporate the new price action.

One thing you do not want to do is adjust your trend line so you can lower your stops. If you buy a stock at support hoping it will go to resistance and it breaks support get out. Do not adjust your support to make it appear as if support is lower now. Getting out quickly when you are wrong can help you in the long run.

Trend lines can be the single most important indicator when deciding when to get into and out of a stock. So it is important to make sure they are as accurate as possible. That means you have to be willing to readjust trend lines every once in a while, and keep them updated.

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