Adjusting Trendlines
In our previous lessons we learned how to identify the major swing points to use for drawing trendlines but as more price data is added to the chart, the trendline may need to be adjusted. In this lesson we will look at when and how to adjust a trendline.
Why Adjust Trendlines?
A trendline can last for a long time but price action rarely proceeds uniformly for a prolonged period. In additions momentum can also cause price action to deviate. At times the price action might not reach the trendline as the trend accelerates. At other times the price might appear to break through the trendline as the trend decelerates. Under these conditions we might need to adjust our trendlines to reflect the change in momentum.
It often sounds problematic when someone says a trendline should be adjusted when the price breaks below the trendline. You're thinking trend reversal but you may be a bit too hasty. An uptrend is characterized by higher highs and higher lows, for a reversal to a downtrend we would need to see lower lows and lower highs. A trendline is not a trend, when the trendline is broken it means that the trendline in no longer valid as support and resistance has shifted. As the trendline is no longer valid, it needs to be adjusted or redrawn. We may need to adjust our trendlines several times during a single trend!
It is important to remember that we are talking about the major trend. We need to keep the distinction between the major trend, the intermediate trend and the minor trend. The intermediate trend interrupts the major trend and reverses quicker than the major trend.
How to Adjust a Trendline
We adjust a trendline to take into account new price data, especially if our trendline is still a tentative trendline. We could make the angle of the trendline steeper or shallower by moving the end of the trendline up or down depending on the trend. This may allow us to include more touches on the trendline. It is important to remember that we want as much touches as possible. If we move the end of a trendline we may end up with only two swing points, in which case the trendline is tentative as three swing points are required for a valid trendline.
We could also ignore price spikes that cut through the trendline but fail to close on the other side of the trendline as the trendline hasn't been broken. In this event, we are using internal trendlines that cuts though the price spikes. We discussed Internal Trendlines in our previous lesson. If the price does close on the other side of a tentative trendline with only two touches, then our trendline is not yet valid. If the price action that broke the trendline forms a new swing point, we can adjust our trendline to the new swing point. Here we have two options: keep our initial swing point and use the new swing point and the second swing point; or move our initial swing point to what was our second swing point and use the new swing point as our second swing point. In other words, we could disregard the first swing point or what was our second swing point. We would still need to wait for a third swing point to validate our trendline. This will ultimately determine if should disregard the first initial swing point or our second initial swing point.
Also, we could reconsider the starting point of our trendline, as the starting point may have been a price spike caused by an over-reaction in the market. In which case, we could move to a subsequent swing point, especially when the subsequent swing point is too close to our initial swing point but bear in mind that we still want as much touches as possible.
If the price does close on the other side of a valid trendline with at least three touches, then our trendline is broken but it may still be a valid trendline. Remember that support becomes resistance, and that there is often a retest of the trendline after it has been broken. If the retest does not break back through the trendline and close on the other side, the retest holds and the trendline is broken. This trendline cannot be adjusted as the nature of the trend is changing. This calls for closer observation of the price action for a possible trend reversal which would require the drawing of a new trendline.
Conclusion
In this lesson, we have learned to adjust a trendline to take into account new price data that has been added to the chart. The aim of adjusting the trendline is to have more swing point touches, but we will often adjust a tentative trendline to locate the more appropriate levels of support and resistance.
In the next lesson we will look at how to trade with trendlines.