I have been asked this question by some readers and wanted to tackle it here. Many have noticed that I do not often use down-sloping or up-sloping trendlines in my analysis and wonder why.
In the earlier days of my trading career, I relied on them rather heavily. However, the longer I ply my profession it seems to me that their value has decreased considerably. I chalk this up to the changing nature of computerized trading. That is another lesson in and of itself but suffice it to say for now that the vast majority of hedge funds do not "think" when issuing buy or sell orders - they REACT, more specifically, their computers react. This buying or selling comes en masse - there is not the least bit of finesse or skill involved with it. It is more akin to a wall of money slamming into a market and brutally shoving it higher or dropping it lower.
In the past, there tended to be more discretion with trading orders - now we have gone over to the systems trader which means the impact on price tends to get exaggerated at times because nearly all of the computers are reacting to the same thing at the same time. This tends to create imbalances in the demand/supply equilibrium in the market which take some time to sort out.
The result of this is an increase in the number of what myself and other technicians refer to as "false breakouts". A wave of buying or a wave of selling hits a market all at once, picks off a huge number of buy or sell stops and price is severely impacted. However, if the fundamentals do not support the technical price action, eventually - and this is always the tricky part - the balance between supply/demand will resolve or correct itself and the underlying trend takes hold once more.
"What in the world is he talking about?" is probably the question that is now popping up in the reader's mind.
Let me give you an example - here is the Weekly Gold Chart. Notice that I have included a sloping downtrend line. I also ran it right to the edge of the paper for a reason... Based on this chart, gold had been in a downtrend for well over a year when this downtrend line was broken to the upside. I remember this well to be honest but that is a different matter. Immediately the cries came forth - "Look out ABOVE - gold is getting ready to blow". We were going to take out $1900 and soar to $2500 for starters based SOLELY on the fact that this sloping trendline had been broken.
Here is the chart after a few more weeks passed.
As you can see, "whoops" is too mild of a word to describe what happened next. After many proclaimed that merely because a downsloping trendline was broken, gold was resuming its upward march, the market proceeded to plummet from near the breakout point of $1,700 all the way down to $1,200 over the next year's time!
Note something important here which I will talk about farther down in this post - the HORIZONTAL LEVEL of $1,530-$1,525 was violated.
Here is the next downward sloping trendline breach... it occurred in August 2013.
The market had pushed past $1,400 and managed to change its handle, a friendly development. In the process it broke that sloping trendline. Everyone "just knew" that it was back to the moon once more.
OH-OH! It failed to maintain the "14" handle for more than one week and down it went - all the way back down to $1,180 again!
After this week's price action, once again those who dismissed technical analysis when it comes to gold, are pointing out the upside breakout above the down-sloping trendline.
Based on what you have seen above, would you feel completely comfortable with the statement that, "gold has broken out and is about to embark on a major rally"? Personally, I would not.
While these sloping trendlines still should be noted and monitored, I prefer to use HORIZONTAL resistance and support levels as I have come to believe from my own personal experience that they are much more reliable. Even at that we still do get some head fakes from time to time with horizontal levels but they seem to have more predictability when it comes to future price action. If some are inclined to differ about this and want to argue, that is fine just do not expect me to come around to that line of analysis. Getting burned a few times while trading is the best antidote for putting ones fingers into the flame with reckless abandon.
Seriously, if trading was as easy as buying breakouts of sloping trendlines, do you not think that we would have hordes of wildly successful traders infesting the nation?
Please keep in mind that being successful as a trader means employing a wide arsenal of tools. It also means learning to not be too dogmatic to the point of obtuseness. Stay flexible - stay nimble and never get MARRIED to a viewpoint. Divorce is usually a costly affair!
"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat
Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput
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