Ask Colin

Why don't you use trendlines, either as confirmation of trends or as exit signals?

This is a complex question that involves several important ideas:

1. I trade trends. Trends are defined by highs and lows in the short term and peaks and troughs in the longer term. Trendlines are a derivative indicator. I prefer to use the price directly. I often make this point colourfully by referring to the circus act where a shooter sights a rifle through a mirror in order to hit targets behind him/her. The mirror gives a derivative image. This is fun for the circus, but in the market, we are conducting a business. There, I prefer to turn around and shoot directly at the target.

2. Trend lines do not define trends. They simply measure the speed of price change over a trend. Thus, they are really simply momentum lines. Now, they are useful, in that they show whether the momentum of the trend is speeding up or slowing down. This may give important warning signals. However, the breaking of a trend line rarely coincides with a trend ending. Sometimes it occurs earlier and other times later. Many trend line breaks never result in a trend ending. Also, many trends do not seem to form good trend lines.

3. Nice consistent trends form good trend lines. I find that I do not need to draw trend lines on these charts. David Fuller says: "If you need a ruler, it ain't there". It is usually perfectly obvious when these lines a re broken. However, even so, the breaking of even the best trend lines does not always result in a trend ending.

4. I abbreviated your question, which also referred to support and resistance. It suggested that trend lines represent sloping support and resistance lines. Some people see them this way, but I do not understand the psychology behind their idea. I do understand the psychology behind levels that have traded before representing pressure points on buyers and sellers. So, if you buy at $5 and the price falls to $4, you feel bad about the trade. If the price rises towards $5 again, you will be tempted to sell there, to "get out even". This is the reasoning behind a broken support level becoming a resistance level. The more people who traded at the $5 level, the stronger the resistance. Similar reasoning can be applied to all horizontal support and resistance levels - i.e. based on getting out even, correcting mistakes, or grabbing previously missed opportunities. However, I do not understand why a price at a particular angle represents support or resistance - i.e. what the psychology of buyers or sellers is.

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