Education: Momemtum Investing

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The Trend is Your Friend: Trend Lines 101

Trend lines are one of the most basic and useful tools for illustrating trends, momentum, and potential reversals. They are usually constructed by connecting two or more (3 or more is preferable) points of the lowest lows or the highest highs. There are no hard and fast rules regarding which points to use. Some traders use the lowest or highest intra-day point, while others use the closing price. Many simply choose to use a line of best-fit, acknowledging that often trends don’t often follow precise patterns.

When to Use the Trend Line

The general rules for using trendlines is to buy on dips at, or near support trendlines, and sell rallies that touch or come close to a resistance downward trendline. Also, a rally that breaks above, or surpasses a resistance down trend line is an indication that the momentum has reversed and a buy is warranted. Conversely, if the stock price slips below an up trend line, the trend has likely reversed and a sell is warranted. The John Deere chart below illustrates these concepts quite nicely.