November 3rd, 2011

Sloping or Horizontal Trendline: Which is More Trustworthy?

I often cringe when I see charts posted on other sites where the author inserts a sloping trendline and then jumps to the conclusion that the trendline will act as some sort of wall of support or resistance as the case may be. The first thing I do when I look at the same chart on my system is to look for and usually find what might be horizontal lines that project a dramatically different interpretation. The question is “Which trendline, sloping or horizontal, prevails and trumps the other?” In making a decision as to whether to buy (or sell) and two lines lead to different conclusions which should you pay more attention to?

I don’t know about you but let’s suppose you bought a stock when its price was at the intersection of both a sloping and a horizontal line. Next, pretend that you were lucky and the stock starts moving higher but then, suddenly begins to correct. Which of the two lines are you going to look to as support? Here’s an example (click on image to enlarge):

This is the chart of DECK (Deckers) you would have seen on September 1, 2010. I you were lucky enough to have gotten on this bandwagon early enough then you would have ridden higher relying on the ascending trendline to act as support. Then in August, 2010, the stock was caught between a rock and a hard place: the horizontal trendline emanating from the stock’s all-time high and that ascending trendline.

We know what happened … it’s what almost always happens when a stock hits an all-time high. That horizontal trendline trumped the ascending trendline which the stock crossed under. Most chartists only look at short-term charts. They would have seen the break of the sloping trendline and would have issued a sell recommendation. They probably wouldn’t have paid much attention to the trendline from all-time high or even known that it contributed to DECK stalling out at that level. But what happened since?

For 6-9 months during 2010, the market was consolidating its huge recovery from the Financial Crash bottom and building for the next wave that began on at the end of August with the announcement of QE2. Deck took that pause to build up its own head of steam to finally cross into all-time new high territory. As the market broke higher, so did DECK. It’s never crossed back above the previous ascending trendline and actually it may be acting as a ceiling of sorts. A new trendline with a shallower slope can now be seen. [For new readers of this blog, I recommend the you read “My Sell Rules” since it’s relevant to the above DECK chart.]

So if I have to chose between an ascending (or descending) trendline and a horizontal one to drive my decisions I would look to the horizontal one. I can’t easily calculate where the trendline will be a month or two out. But I can easily see whether there are any horizontal trendlines that mark where buyers and sellers have traded places for control of a stock’s trend. Those are the transfers of power that I rely on to help me anticipate what might be ahead for a stock (or Index).

In the DECK’s case, there’s potentially a neckline at the 70-73 level which could turn out to be important some time in the future should DECK cross under that new sloping trendline. Whenever that happens, there will be other new horizontal trendlines to draw that will act as milestones along the way.

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  • Bobosqueakers

    After reading many columns, blogs, etc and doing fairly well investing on my own I might add..(we're talking about many years worth here) I discover yours and its as if the rest of the BS washes away and the clarity and logic of your comments illuminates Charting in a whole new way or rather a very experienced and knowledgeable way. thanks.

  • Joe

    Bobo, thank you for the very kind words. I have also been trading for many years (some more or less successfully than others) and continually strive to make some logical sense of the whole process.

    I think I've come up with a process that works, at least for for me, and enjoy sharing it with others.