Technical analysis is built on the assumption that prices trend. Trendlines are an important tool in technical analysis for both trend identification and confirmation. A trendline is a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance. Many of the principles applicable to support and resistance levels can be applied to trendlines as well.
Up Trendline
An up trendline has a positive slope and is formed by connecting two of more low points. The second low must be higher than the first for the line to have a positive slope. Up trendlines act as support and indicate that net-demand (demand less supply) is increasing even as the price rises. A rising price combined with increasing demand is very bullish and shows a strong determination on the part of the buyers. As long as prices remain above the trendline, the uptrend is considered solid and intact. A break below the up trendline indicates that net-demand has weakened and a change in trend could be imminent.
Down Trendline
A down trendline has a negative slope and is formed by connecting two or more high points. The second high must be lower than the first for the line to have a negative slope. Down trendlines act as resistance and indicate that net-supply (supply less demand) is increasing even as the price declines. A declining price combined with increasing supply is very bearish and shows the strong resolve of the sellers. As long as prices remain below the down trendline, the downtrend is considered solid and intact. A break above the down trendline indicates that net-supply is decreasing and a change of trend could be imminent.
Scale Settings
High points and low points appear to line up better for trendlines when prices
are displayed using a semi-log scale. This is especially true when long-term
trendlines are being drawn or there has been a large change in price. AmiBroker
allows to set the scale as arithmetic or logarithmic (semi-log). An arithmetic
scale displays incremental values (5,10,15,20,25,30) evenly as they move up
the y-axis. A $10 movement in price will look the same from $10 to $20 or from
$100 to $110. A semi-log scale displays incremental values in percentage terms
as they move up the y-axis. A move from $10 to $20 is a 100% gain and would
appear to be a much larger than a move from $100 to $110, which is only a 10%
gain.
Please remember however that straight line in the log chart is no longer straight in the linear scale, so trend lines drawn in one scale may look strange in the other scale.
Validation
It takes two or more points to draw a trendline. The more points used to draw the trendline, the more validity attached to the support or resistance level represented by the trendline. It can sometimes be difficult to find more than 2 points from which to construct a trendline. Even though trendlines are an important aspect of technical analysis, it is not always possible to draw trendlines on every price chart. Sometimes the lows or highs just don't match up and it is best not to force the issue. The general rule in technical analysis is that it takes two points to draw a trendline and the third point confirms the validity.