financial trading apps Tips for Trading Trend Lines: Lower Highs and Lower Lows

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Let us assume that you have a stock that is rising steadily, and you have drawn a valid trendline connecting the higher lows in the price. In another article, we talked about what can happen when a trend line is broken, and how it can be a dangerous time to be in the market, until you see what the stock is doing.

This time, we consider what would make the stock worth trading on again, if this is a true reversal. Reversals do not generally happen in an instant, but come about when there is a decline in buying interest and perhaps an increase in selling interest. The market is generally deciding that the stock is not worth pricing at a higher level. Often the market will go on to decide that the stock is overvalued and the price needs to be corrected downwards.

Consider what you might see when you are following a stock price rising up a trend line. Perhaps just before the trend line is broken, you will see that the high is a little lower than expected and that the trading volume is reducing. The trend line is broken by the price dropping down through it, but the price attempts to recover and perhaps even rises above the trendline again. If this is a reversal, you can expect the price to fall down again, perhaps with increased volume of trading as more market participants decide what is happening.

Can you see what is going to be represented on the chart? A declining second peak, and a lower still third peak will give you the classic head and shoulders pattern, a reversal pattern which has its own criteria for validation. By connecting the low points each side of the head and extending outwards, you can draw the neckline which helps in validating the pattern and also setting a target price that should be reached.

You will recall that the head and shoulders pattern is regarded as confirmed once the price drops down through the neckline after the right shoulder. In fact, the neckline may subsequently prove to be a resistance level, if the price comes back up to challenge it.

The classic method to determine a price target from the head and shoulders is to measure up from the neckline to the top of one of the shoulders, whichever one gives a greater distance. This distance is then transposed downwards from the point that the price goes down through the trendline, and by drawing a horizontal line at this level you have a target price that should at least be reached in the current stage of the downtrend.

It is important to note that sometimes you need to change the chart timescale in order to see more clearly what is happening to the price. Sometimes the head and shoulders pattern will only be distinct on a particular time scale, and will pass unnoticed if you concentrate on only one chart. Be sure that you are taking the overall view of how the security is performing before you enter any trades.

financial trading apps Tips for Trading Trend Lines: Lower Highs and Lower Lows
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