Trend lines are defined by lines. A line is just a connection between two points. An upward sloping trend line is bullish, a downward sloping trend line is bearish and a horizontal trend line is neutral.
Initially we connect two extremes or two high points (point A and point B) and create Trend line 1. When trend line 1 is violated by moving above the line, we identify the point highest above trend line which is point C. We now connect Point A with point C and you have the new trend line 2. You can see that both trend lines are down and bearish. Trend line 2 is not really violated for six months, this occurs in late March and it is here that the trend appears to have changed.
Let’s examine the trend lines for the bullish 4+ year chart of the S & P 500. Point A is the low from which the market rallied. Point B is a low point created on a reaction from a price move to the upside in late April of 2010. Trend line 1 stayed intact until August of 2011 when the trend was broken. The reaction low was point C and if you connect point A with point C you have the new trend line 2. Trend line 2 has yet to have been broken.
In the above figure I have used a low point in a market correction at point A and connected to another low point on a correction at point B to create the trend line.
I have created a parallel line next to the trend line making a trend channel. You’ll note that the upper limits of the trend channel provide resistance to the price movements and the lower limits of the channel provide support for price movements.
In June, the S & P 500 broke the trend line which was a warning sign. The markets proceeded to move back above the trend line in early July and subsequently tested the trend line again in late July. The question now is whether the S & P 500 will move back to the top of the trend channel or whether the trend line will be broken again.
If you haven’t noticed we’ve been slowly focusing in on the more recent behavior of the S & P 500. Notice that there has been little real progress since the high in June. I have placed a horizontal trend line from the high in June to the present. A 2% pullback by the S & P 500 would bring prices down to that line which is basically providing support. A move below that line would suggest a test of the major long term support line. A move below the major support line would suggest the completion of a major market top.
What this analysis of trend lines has given us is a feel for the markets. Would’t you agree?
If you have any questions please be sure to write a comment! I know this is a lot to take in but it is doable for all of you.