Here's a quick excerpt from Sylvain Vervoort's brand new book, Capturing Profit withTechnical Analysis. In this example, Vervoort walks us through how trend lines can be used over the long term. [taken from Chapter 1 Technical Analysis Basics]
***Trend Line Application
A long-term investor using a monthly chart could act upon a number of trend lines. Figure 1.20 shows all the trend lines used. We assume trading both long and short.
1. At the end of 1992, the closing price breaks above the downtrend line. This is a buy signal.
2. After a first reaction, the price moves up again during the second half of 1993. This is a clear
second pivot point for drawing a longer-term uptrend line. Note that from this point on, the price is accelerating and, in time, moving farther away from the uptrend line. The best thing to do when this kind of move develops is to follow the new move with a new, sharper trend line.
3. Beginning in 1994, the price drops below the uptrend line. It’s time to close the long position and open a short one. The idea is to buy the stock back at a later date at a lower price to make a profit.
4. In the second quarter of 1995, the price rises above the downtrend line. This is a signal to close the short position and open a new long one.
5. Note that at a certain point in time, the price moves farther away from the trend line again. You can start a new, sharper uptrend line.
6. In the third quarter of 1998, the price drops below the uptrend line. You must sell the stock and open a new short position. In just two months, the price drops dramatically. When you see this kind of movement, it is a good idea to change from a monthly chart to a weekly or even a daily chart. With this kind of move, you must take the short-term profit. As soon as there is a trend line break on the weekly or daily chart, just take the profit. You would then wait for the long-term downtrend line to be broken before taking any new action.
7. The downtrend line is broken in the second quarter of 1999. If you haven’t done so already, you should close your short position and buy the stock again for a new long position. After a big move down in a short time period, it usually will be difficult to draw a new trend line from the lowest point reached. The new uptrend line will have to start with one of the following bars or previous bars.
8. Beginning in 2001, the price falls through the uptrend line. This means that you close your long position and open a new, short position. Again, the accelerating down-move means that you have to draw a faster, declining downtrend line.
9. The price moves above the downtrend line in the beginning of 2002, so you close the short position and open a new long position.
10. The uptrend line is broken in the second quarter of 2002. You sell the stock and open a new short position. Again, the price drop is large and fast, which means that you have to go for the short-term profit.
Trading Result
The following table displays the result of trading long and short positions each time the trend line is broken at the end of the month. A starting equity of $25,000 would have become $249,855 after about 10 years. This is 10 times the starting capital, or a composite interest rate of more than 25% per year, which is not a bad result for looking at just one chart, once a month.
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