What’s My (Trend)Line?

[youtube:http://www.youtube.com/watch?v=PUXdrS2N4nM 550 412] __________________________

There is a cartoon where a woman comes home to discover her husband in bed with another lady. Seeing that his wife is both stunned and furious, he blurts out, “No, I’m not cheating!” And then he follows it up with the old Groucho Marx line, “Who are you going to believe? Me, or your lying eyes?”

Traders drawing trendlines on charts can often be so biased that they undermine the whole purpose of the exercise. If they are bullish and have money on the line, they will exhibit enough creativity to earn a master’s degree in geometry in order to show that a particular uptrend is still intact, and vice versa. Of course, that begs the question of what, exactly, amounts to objectivity in technical analysis trendline drawing.

The answer is that the market tells you just how valid your trendline is, and it is up to you to decide whether to listen. The more “touches” or times that the market reacts to a trendline that you have drawn, the more significant it is. In order for the trendline to hold any kind of validity, you are looking to see three touches. After all, anyone can simply draw a line from point A to point B on a chart and declare it to be the mother of a trendlines.

To rehash the basics, in an uptrend you will want to draw a support trendline along the lows of prices, and in a downtrend along the highs for a resistance trendline. Also, a trendline with a steep angle, in any direction, should be viewed with a cautious eye, as the one-sided action is not likely to last for very long and is prone to a sudden, violent reversal. Moreover, just because a trendline is marginally breached does not necessarily mean that a major inflection point is underway. In fact, trendlines are often breached at various times throughout a larger trend, such as a bull market, but that does not mean that a fresh bear is upon us. Instead, the trendline is breached when it likely becomes so ubiquitous that some weak hands need to be shaken out before eventually turning higher. After all, when everyone is watching and thinking the same thing, no one is thinking.

In the case of Las Vegas Sands, we see a weekly chart below that has reacted to a simple support trendline at various points since bottoming in the $1 range (!) in March of 2009. During the magnificent bullish move of LVS over the past two-plus years, this support trendline had been touched multiple times in 2009 and 2010, but had not been tested in about eleven months until this week. As you can see, the stock reacted favorably once again to the trendline.

To state the obvious, this weekly trendline will not hold forever. However, it has survived multiple tests over  two-plus year period exceptionally well. In particular, the trendline held this week AFTER Las Vegas Sands has already seen a major, multi-month correction, which gives ammunition to the thesis that the stock is bottoming here. Why am I so confident in this trendline that I pulled out of thin air and drew on my chart? Because the market told me it was significant.

So, who are you going to believe? My trendline or your lying eyes?

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