Technical analysis and drawing trendlines can keep you informed about the trends unfolding in your investments and may even support your decision making.
From falling and rising hemlines in fashion, to falling rates of poverty and rising life expectancies around the world, trends are everywhere. When it comes to stock prices, it seems no matter what the economy is doing, or whether the Fed will or won’t hike interest rates, you can always find some stocks that are rising, falling, or doing a whole lot of nothing.
With stocks, the word “trend” refers to the prevailing direction of price movements. There are generally three ways prices go: up, down, or sideways. Uptrends can be defined as a series of higher lows and higher highs in price over time. Conversely, downtrends can be defined as a series of lower highs and lower lows in price over time. Sideways trends are roughly equal highs and lows over time.
One quick and easy way to determine the trend of a stock is by looking at a chart of historical prices. For instance, figure 1 shows an uptrend in the Utilities Select Sector Index ($IXU) since the beginning of 2016.
FIGURE 1: UPTREND IN UTILITIES SELECT SECTOR INDEX ($IXU).
The $IXU created a series of higher lows and higher highs since the beginning of 2016. Image source: tdameritrade.com. For illustrative purposes only. Past performance does not guarantee future results.
Looking at historical prices on a chart and identifying a trend in highs and lows is a relatively straightforward task. But there’s a problem: those prices are in the past and don’t guarantee anything about the future.
Drawing trendlines is a way of extrapolating historical trends visually on a chart. For an uptrend, investors might use the series of higher lows to draw a trendline. Figure 2 shows a trendline based on the series of higher lows in $IXU.
FIGURE 2: UP TRENDLINE CONNECTING HIGHER LOWS IN $IXU.
The $IXU dropped to its trendline in mid-August, testing the pattern of higher lows. Image source: tdameritrade.com. For illustrative purposes only. Past performance does not guarantee future results.
As you can see, $IXU recently dropped to test its trendline near 500. If it drops below the trendline, it could signal a longer-term change in trend. That’s because the series of higher lows would be broken, and a new series of lower lows could unfold.
Some investors might set a stop-loss slightly below a trendline, thinking that if price carves out a lower low, then it might have further to fall. Of course, there’s no guarantee that $IXU will keep falling even if it does break below its trendline. Sometimes markets bounce back.
Other investors might buy a put option to protect against potential further declines if $IXU breaks below its trendline. A put option gives the buyer the right, but not the obligation, to sell typically 100 shares of stock at a predetermined price and by a specific date. A put option can hedge against declines in stock prices, but only after accounting for the cost of the option and transaction costs.
Whether you decide to take action when a market breaks a trendline or not, identifying trends in stocks you own is a good way to stay on top of your investments. Drawing trendlines can keep you informed about the price action unfolding in your investments, and may even support your decision making.
Log in to tdameritrade.com to access tools, research, and social opinion all in one place. Practice drawing trendlines on charts.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2018 TD Ameritrade.