Technical Analysis is a vast subject. There are more techniques and indicators than you can count and they seem to be growing in complexity as well as in complexity of interpretation. This article introduces just a few core concepts and recommends a trading strategy based on those concepts. Though simple, these concepts are among the most effective. They can serve as a foundation for further learning. Once you’ve mastered the basic ideas presented here, you can try it out on historical data using the Trade-A-Stock application.

Concept 2: Highs, lows, and whether they are higher or lower.

Stocks are always oscillating, even during a trend. When a stock price changes direction or pivots in a significant way, this creates either a high or a low.  The highs are depicted with red circles in the drawing above while the lows are depicted with blue circles. The low is the lowest price of the day where the stock pivots and begins to go upward. The high is the highest price of the day where the stock price pivots downward.

1. •Identify an uptrend by looking for a sequence of highs that increase in price (these are higher highs). Look for lows that are increasing in price (higher lows).
   

1. •Identify a downtrend by a sequence of lows and highs becoming lower in price, hence, lower lows, and lower highs. If there is no discernible trend in the highs and lows, then you are in a trading range.
   

The next few charts illustrate these concepts on real data.

Highs are red. Lows are blue.

Higher highs and higher lows in an uptrend

Lower highs in a downtrend

A stock in a trading range

Concept 3: How to Draw Trend Lines

Whether a stock is trending up or down is visually easy to spot, but drawing a trend line is a specific exercise which provides key entry and exit points. When defining trend lines, lower highs determine the down trend line. Higher lows define the up trend line. To draw the line, imagine you have a ruler and are connecting the dots between the higher lows ( uptrend ) or the lower highs ( downtrend ). Thus, for a downtrend, all of the prices should be below the trend line. For an uptrend line, all of the prices should be above it.

1. •You must make sure that todays prices are above the trend line ( for an uptrend ) or below the trend line (for a downtrend).
   

1. •The line should be as long ( with respect to time ) as you can make it while still capturing the general trend. The longer the line, the more solid the trend and the more likely it is to continue.
   

1. •The more highs or lows that touch the line, the stronger the trend.
   

1. •Try to connect highs or lows that are separated in time by at least a few days.
   

1. •Don’t use the most recent prices to draw a trend line.
   

1. •Trend lines should extend for at least a month, but should not be much longer than a year.
   

Connect the higher lows to draw an uptrend line. This one looks about to be broken because the low of the most recent day penetrated the line.

Connect the lower highs to draw a downtrend line.

Concept 4: Trend Line Break

1. •Trend lines invariably break. When they do, they are no longer valid. You can attempt to draw a new line that encompasses more recent data. If nothing jumps out at you, then you have likely entered a trading range.
   

1. •A side note: If you’re able to draw two trend lines (one up and one down), then defer to the longer term trend line. If they are more or less equal in duration, then you have a price consolidation pattern, and no trend, so ignore both lines until one has been broken.

A trend line is broken and the stock slips into a trading range.

Trend Trading Strategy

Now that concepts are defined, it is time to create a complete trading strategy based on the relatively simple premise that trends, once begun, tend to keep going. A complete trading strategy has entry rules, stop rules, and exit rules.

Entry Conditions:

1. 1.Visually identify a stock that is trending and has clearly broken out of a trading range. Note, more often than not a stock is in a range, so don’t trade it unless the trend is obvious.
   

2. 2. Draw a trend line.
   

3. 3. Enter the trade (long or short) in the direction of the trend when the price gets close to the trend line.  (What does long or short mean?)
   

Stop Rule: (What is a stop? Click Here)

1. 1.Place an initial stop below ( if long ) or above ( if short ) your entry price. The stop should be about 2-3 times the average daily movement of the price of the stock. For example, if the stock tends to move about a dollar on any given day, then place the stop 2 dollars away from either the trend line, or the entry price. You can calculate the average daily price movement in the Trade-A-Stock app using the ATR (average true range) indicator.
   

2. 2. Move the stop in the direction of your trade, following the trend line as the trade progresses. Keep it below the trend line.
   

3. 3. A stop can only move in one direction, never adjust it in such a way that your loss can get bigger.
   

Exit Rule:

1. 1.If the price closes significantly below your trend line ( 1% or so ), then exit the trade; the trend is broken.

Enter long when the price nears the trend line, place the stop below the trend line and move it upward as the trade progresses in your favor. Just reverse this process for a short trade.

Assuming you’ve entered long, look for the price to close significantly below the trend line ( about 1% ). In this chart, it touches, but doesn’t break the line.

Here, the trend line is finally broken and it is time to exit.

Below is an example of a chart that has no clear trend. Multiple trends have been broken. When in doubt, take a step back and just look at the chart, if no trend is obviously apparent, don’t trade.

The purpose of this article is to give you just enough technical analysis to peak your interest in the subject and to arm you with enough information to get you started using the Trade-A-Stock application. NonRandomWalk.com is not intended to be a technical analysis school, but rather to give you a place to validate your own ideas about trading. Chances are, if you found this site, then you already know something about technical analysis. Click here for a list and explanation of technical indicators in the Trade-A-Stock app.

Below is a list of a few other online sources of information in the subject area.

1. •Swing-Trading-Stocks.com has a comprehensive overview of a swing trading strategy, very similar and more comprehensive than the one presented here.
   

1. •Stockcharts.com has excellent tutorials on all aspects of technical analysis at their chart school.
   

1. •Finally, below is a short, pithy video on the basics of technical analysis and how to use a few technical indicators.
   

Non Random Walk.com

Technical Analysis (For Beginners)

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Concept 1: Trends and Trading Ranges

Stocks trend and stocks oscillate (pictures below). When stocks oscillate, they moving like a sine wave and tend to end up back in the same place they were before. This sideways movement is called a trading range. When stocks rise or fall in a prolonged sustained way, that movement is called a trend. Even when trending, prices still oscillate, as shown below. When trading, you need to be able to clearly identify whether your stock is trending or is in a trading range.  Warning: stocks spend most of their time in trading ranges. If you can’t tell if a stock is trending with a quick glance, then it is in a trading range.