The Most Important Concept in Technical Analysis

The trend is the most important concept in technical analysis.

Its strength or weakness can dictate the overall direction of your favorite stock or index.  Potential uptrends can be characterized by a series of higher highs.  Potential downtrends can be characterized by lower lows.

Look at the NASDAQ Biotech ETF (IBB), for example.

For years, it ran higher on the heels of 80 million retiring baby boomers, newly insured Americans, new innovation, mergers and acquisitions, and heavy demand for new treatment options.  The fundamentals were there.  No one could argue that.

But even technical analysis presented us with a catalyst we couldn’t ignore.

This particular uptrend was characterized by higher highs, and a supportive 50-day.  In fact, for six long years, that trend line remained intact.

Any one that took advantage of it stood to make a fortune.

To identify trends, we can always rely on the 50 or even 200-day moving average, but we can also do it by drawing our own lines. 

Any time there are two highs or two lows a trend line can be drawn and identified. All we have to do is connect the highs or lows on the chart, and we begin to see trend.  Look at the US Dollar for example.

Clearly, we can see that it’s in a crippling downtrend.  A disaster, if you will.

But what if you had the opportunity to spot that potential downside months ago?  Simply by drawing trend lines, connecting highs and lows, we could.

By late March 2017, we had two lower lows following a test of 104.  By connecting those, we could identify trend.  We also now had an argument that if said trend line was broken, the potential for further downside was a possibility. 

We could also then draw new trend lines by late May 2017, connecting recent highs and recent lows to understand potential direction of trend, too.  We could then argue that should the dollar now break above the upper trend line at 95.58, a new uptrend is perhaps a possibility. 

Or we could argue the dollar could just remain in that tight downtrend.

All we can do is speculate with trend lines.  But we have a better argument for what’s possible if we pay attention to them.

Of course, we never just want to rely on trend lines to buy or sell.  It’s essential that you also confirm your findings with other indicators, such as Bollinger Bands, MACD, RSI, Williams’ %R and Money Flow just to be safe.