Why do prices follow trend lines?

[GreatPig]

As anyone who's looked at technical analysis knows, prices will often follow trend lines for periods of time.

Why do they do that? Is it because a lot of people use TA and keep pushing prices back up when they drop below their own trend line? From what I've read, I gather the majority of investors don't use TA, so how would they know where a trend line is?

For example, take ARQ. I've had a trend line covering about the last three years drawn in for many months. Now look at yesterday (see attached). Prices dropped well below the line but at the end of the day were pushed back up for a close almost exactly on the trend line.

But since it's a sloping line, that price is not one that's particularly significant, other than for the fact it's right on the trend line. Likewise for the time in late December, which was already the 4th or 5th point of contact to the line.

So while it's nice that these things happen, it does make me wonder how over such long periods prices can still come back to touch trend lines so exactly.

Cheers,
GP

 

[ctp6360]

GreatPig, I'm not sure if you have read it already but the book "Trading for a Living" delves deep into the psychology of trends and offers an explaination as to why prices follow trends.

His main point is that people have memories and so they tend to follow historical patterns.

The book goes into a lot of depth, if you don't really want to buy the whole thing (it cost me $120) then I would be happy to scan the relevent pages for you.

 

[GreatPig]

His main point is that people have memories and so they tend to follow historical patterns.

No, I haven't read that particular book.

I can see memory accounting for horizontal resistance and support levels, but for sloping trend lines?

Surely people don't do linear extrapolation in their head to determine what the price they paid earlier would be now based on how fast a stock has been increasing on average.

Or maybe they do...

Cheers,
GP

 

[bullmarket]

Hi GreatPig

I think you might be underestimating the number of people that look at charts before buying/selling.

I agree that maybe the majority don't do any highly technical TA but I would be surprised if a very vast majority of people don't at least have a look at a basic line chart of closing prices (at least from the prolific number of free sources available on the www) and 'eye-ball' trends, supports/resistance etc before buying selling.

Re sloping trend lines - in addition to the above, I suppose if people see a stock that has been trending up and then see a pull back, they could easily think, assuming the company's outlook is good, that supply (sellers) of shares might not last down to the previous low and so keen buyers will tend to start buying again earlier than the last low and hence start pushing the price back up. The fact that sometimes these lows within an uptrend tend to form a sloping line is just part of human nature/psychology and who knows what else (I have enough trouble working out what is going on inside my head let alone anybody elses )

Vikky-Verky for downtrends I suppose.

cheers

Bullmarket

 

[Knobby22]

That trendline you use as an example has only two points. It would work if the second point was different.
Doesn't mean anything.

 

[WaySolid]

Personally I'm a trend line skeptic. I rarely use anything other than horizontal lines.

I see so much junk posted on the net that I'm probably too dismissive of them sometimes. Plenty of ways to make money though so I can believe they are worthwile. Like most T/A it's very difficult to quantify the value of something as it's hard to measure the failure rate.

Apparently DeMark's 'Qualified Trend Lines' are used by some large traders according to Larry Williams. Basically just an approach that specifies when a trend line break will have merit.

One point I would make is that you must draw a trend line through two different specific price points otherwise it will be variant with changes in chart scale.

 

[bullmarket]

Hi WaySolid

To be honest, I draw sloping trend lines for the sake of completeness on a chart but I too place much more emphasis on horizontal support/resistance lines than on sloping trend lines.

I go by the traditional definition of an uptrend - a series of higher highs and higher lows. If the share price eventually falls below an upward sloping trend line joining the lows (troughs) in an uptrend but is still above the previous trough in the overall uptrend, then I would see that as a signal suggesting the momentum of the uptrend is weakening but with the uptrend still technically intact. But some chartists would say the uptrend is over as soon as the price falls below the upward sloping trend line. I suppose it depends on one's definition of an uptrend and what signals the end of the trend.

I would imagine that the time frame one trades/invests in might also have a bearing of one's definition of an uptrend.

Vikky-Verky of all the above for downtrends (that saves me a lot of typing )

cheers

bullmarket

 

[GreatPig]

That trendline you use as an example has only two points

I only showed two, but there were two others well before that (in 2002 and 2004) and a couple more again that came very close but didn't quite touch.

Cheers,
GP