Timing is everything when buying and selling stocks. After all, the basic rule of investing in stocks is to buy low and sell high. With stock prices adjusted every minute while the market is open and even after it has closed for the day, you need to time your stock activities properly in order to maximize your return. Understanding how to properly analyze data that is provided to you in a graphical format is necessary if you want to time the market correctly. When you understand more about what a trendline is and how to draw one, you can make more educated buying and selling decisions.
A company’s stock price is usually a direct representation of its earnings and profits. You can easily look at a chart of historical stock prices to determine how well a company has performed historically. A trendline is a technical analysis tool of this chart that makes it easier for investors to determine if now is an ideal time to buy or sell stock in a specific company. All stock prices will go upward or downward numerous times per day, but a trendline tells investors the general direction the price is headed over a period of time. After you learn how to draw a trendline yourself, you can be a savvier investor who can better time investment activities.
What You Will Need to Follow This Tutorial
Before you can walk through the steps for drawing and analyze trendlines for your stock picks, you will need to follow a few initial steps to prepare for this tutorial. A trendline analysis is a rather straightforward process to complete, but it does require that you have the right data in front of you before you can draw the analytical lines.
Select Your Stocks Through Fundamental Analysis
It is unreasonable to plan to draw trendlines on dozens or hundreds of stocks, so you must first make a few stock picks to analyze more carefully. A fundamental analysis of stocks will help you to determine which stocks to purchase, and a technical analysis of trendlines will tell you when to buy the stocks. Therefore, the first step in the process is to use a fundamental analysis process to pick the stocks that you want to draw a trendline for. Consider what your driving factors are for narrowing down the options that you want to complete a fundamental analysis on.
Determine Your Timing Interval
The creation of a trendline takes any two or more points on an earnings or stock price graph. A straight line is drawn between these points, and this line should not curve or bend in any way. As an investor, you may be well aware that the graph of a stock price can look significantly different if you zoom into the stock prices based on a single day’s numbers versus if you zoom out to prices over the course of several days or weeks. Your trendline data points should take into account how long you plan to hold the stock. Keep in mind that investors who choose companies that are fundamentally weak usually hold a stock for the short term. Long holds are typically desired for companies that are fundamentally strong. If you plan to sell the stock within a few days, for example, you may want to look at a five-day chart to create your trendline.
Select Your Points
Many investors who draw a trendline for a specific stock will look at a detailed analysis of prices as they move throughout the day over a specific interval of time. Therefore, there will not usually be a minimum of two points. Instead, there may be hundreds of points that all go generally upward or downward in a trend or visible fashion. When selecting your points, however, you want to pick the troughs or low points when you spot an upward trend. If you spot a downward trend, the points you select should be peaks or high points over the time frame.
Consider Using a Software Program for Easier Drawing and Analysis
Drawing and analyzing a trendline can seem easy, but you can draw dozens of trendlines on different stock picks based on different timing intervals before you make a decision about when and how to trade. With this in mind, it may be a time-saving measure for active investors to carefully select a software program that is designed specifically for this purpose. There are several affordable options available to consider that each have different benefits and features. For example, some will take into account your desired time frame and will instantly create graphs of trendlines for side by side analysis This is a timesaving feature that may help you to make better stock investment decisions.
Trendlines – Step-by-Step Instructions
If you have decided to draw trendlines for stock analysis on your own, you may be wondering what it takes to draw and analyze these lines. You can walk through these step-by-step instructions to understand the basics of this process.
Walk Through the Fundamental Analysis Process to Pick Your Stocks
Initially, you should pick a handful of stocks that you may be interested in investing in. Each investor has different reasons for choosing to invest in specific companies. For example, you may want to diversify your portfolio into the biotech sector, so you may only be looking at biotech stocks today. A fundamental analysis of each of the companies is necessary as a first step because this type of analysis tells you which companies are strongest and are worthier of your investment. Pay attention to the price per earnings ratio, company management, market saturation, growth plans for the future, company debt and other factors. Keep in mind that a weak company does not necessarily mean that you should not invest in the company. Some investors will profitability invest in weak companies with a short-term hold. Determining if a company is weak or strong from a fundamental standpoint can tell you which companies are more well-suited for the length of hold you had planned. Your analysis of how strong or weak a company is also will be important later when you analyze the trendlines of the stock prices.
Choose Your Points Carefully
Based on your investment plans as well as your fundamental analysis of the company, you can better determine the time frame of stock prices that you should be analyzing. All stock prices have their highs and lows when you look at the prices over a specific time interval. However, through a basic visual review of the graph for the time interval you have selected, you can determine if the stock prices have an upward or a downward trend. For an upward trend, you will pick two or more points that are valleys or the lowest dips in stock prices. For a downward trend, you will pick two or more of the highest points. The best trendline will incorporate three or more points into a line rather than relying only on two points. The more points you can incorporate into your line, the more accurate your analysis will be. Remember that connecting different points that are farther away from each other can alter the slope of the line. It may also make it impossible to connect some points in between the endpoints you have selected.
Draw Your Trendline
After you have selected the uppermost points to connect in a line for an downward trend or the lowermost points to connect for an upward trending line, you can connect the points in a line. The line should be straight rather than curved or bent. There may be cases when a stock price trends upward and then downward or vice versa over the time interval that you have selected. When this happens, you should analyze both trends on either side of the significant peak or valley. Keep in mind that a stock that has been steadily trending downward and has only recently started to trend upward requires special analysis to determine if the stock will continue to trend upward in the future. When this happens, it is also important to research why the trendline changed directions. Therefore, the analysis of your graph is open to some interpretation.
Know How to Analyze the Graph
Generally, a trendline that has more points is determined to be a more reliable predictor of what prices may do going forward. In addition, a trendline that has a steeper slope upward or downward is a riskier investment than one that has a more gradual slope. Therefore, you need to analyze the slope of the line, the number of points used to create the trendline and the timeframe that was used to determine how you should use the data that you now have. You also need to consider how evenly the points are spaced. When the slope of the line is heavily dictated by two or more points closely clustered to together or very far apart, the validity of the line many be in question. In some cases, you may have one or two sharp drops below the line that you did not want to use in your trend line analysis. You may have a justified reason for not including these points in your analysis. However, generally, a reliable trendline will not have any points that break below or above the line.
Avoid Manipulating the Graph Based on Wishful Thinking
As you might imagine, it is easy for investors to manipulate the analysis of trendlines to justify their emotional impulses to buy or sell stocks. For example, an investor who may be looking for a justifiable or quantifiable reason to sell a stock that has only recently started to decline in price may narrow the trendline time frame to a very short period of time. As an investor, it is important that you remember the fundamental rules regarding the analysis of trendlines. These include the need to select points that are reasonably spaced apart. You also should be particularly weary of trendlines that were drawn with peaks or troughs that were disregarded for a specific reason. Remember that the most reliable trend line does not have any breaks in it. In addition, take note that stock prices do move regularly. Because of this, it is important to continue to monitor stocks carefully that seem to have a changing trendline direction. The slope and direction of trendlines can change rather dramatically over a rather short period of time. If you decide to act based in part on a trendline, you should act quickly.
Determine When and How to Act Based on the Trendline Data
A trendline is an excellent analytical tool for investors to use when trying to time investment activity. However, this is a tool that also can be misused easily because it can be manipulated. If you want to better analyze the data and know when and how to act based on trendline data, you must also take into account the trough and peak analysis and other relevant analytical factors. Furthermore, it is important to note how far above or below the trendline the price closed at. The farther away the closing price of the stock is from the trendline, the more likely you are to be seeing a change signal in the trendline. Remember that change signals in trendlines are more ideal for investment activity, and you should study how to read and analyze trade signals in order ot be a smarter and more profitable investor.
As you can see, drawing a trendline seems rather straightforward, but it is easy to use bad points or to analyze the data incorrectly. Understanding more about how trendlines are accurately drawn and analyzed can help you to become a savvier investor. Remember to always take a trend line analysis into consideration with other analytical details so that you can form a more well-rounded decision. Avoid solely relying on this form of analysis to make your decision. Please leave your comments about the article in the space provided below, and share the article with your fellow investors if you believe it would be helpful to them.