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Channels of the Trend
The trend line acts as underlying support to up trend lines and overhead
resistance to down trends. We also can observe that prices once finding
support (resistance) will move ahead and away from the trend line then
return to the trend line. Over time we can recognize that this meandering
course of price movements to and from the trend line form a channel of
variance from the trend line and in the direction of the trend. So what is
going on here. There are buyers who are committed in varying degree to
prices going up, sellers who are similarly convinced that prices are headed
down and that that large undefined mass of the uncommitted, observing the
buyer/seller dynamic turmoil and joining the fray when they are convinced
that one or the other is in ascendancy. |
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In an up trend, as prices reach the up trend line, new increased buying
comes into the market in such strength as to overwhelm the selling of the
sellers. These buyers are made up of previous buyers in the market adding to
their positions, intending buyers who missed earlier opportunities and are
now buying the dip. Previous sellers who didn't cover their short positions
on the last price rise are now sufficiently encouraged that they are, and
have been, right all along, nervously leave their short positions on and so
their effect at this point is neutral. The buying that aborts selling at the
trend line impresses some of the previously uncommitted, now convinced that
the buyers have the upper hand, buy. This new buying takes prices up and
away from the trend line and the further it moves up the more impressed the
uncommitted become and more buyers come into the market, and more of the
previous short sellers become frustrated and buy to cover their short
positions and prices move up further. After a while buying becomes exhausted
and is overwhelmed by selling by profit taking previous buyers and new short
sellers who are selling the strength on what they perceive to be a selling
opportunity. As buying is overwhelmed more profit taking occurs and nervous
recent buyers will have their close trailing stops triggered as market
orders and so prices retreat to the trend line again when the whole cycle
starts off again if the up trend is to continue. This to and fro, buying and
selling in the direction of the trend plots out a recognizable channel of
dynamic flux of the trend. |
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Recognizing the trend line and the opposing parallel channel line - channel
return line - and understanding the human dynamics that account for its
structure we can increase the efficiency of profit making by initiating or
adding to one's position at trend lines and profit taking at the channel
return line. One can, but I do not usually, trade the retracement. For those
who do not wish to trade the trend so aggressively one can use the trend
line for placing and moving stops. Recognizing the violation of the trend
line and when to initiate trades in response to trend violation one can have
a recognizable entry level to trade the new trend. Also, as the trend
progresses one can recognize support and resistance levels which can also be
used for further trading on the placement of stops. |
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Broadening the concept
Trend lines can be
demonstrated on prices charts. Proxies for the trend are often used for
technical analysis of prices, common examples are moving averages and simple
linear regression analysis. The concept of channels about these proxies is
established. These channels are often called bands and are placed above and
below the proxy for the trend. These can be created in several ways e.g.
visually, a fixed percentage from the proxy to contain 80% or more of the
variance from the proxy or as a standard deviation (SD) from the mean
(usually 2 SD to give approximately 95% of the variance from the mean). |
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