More on Trendlines

Chad left the following comment on my earlier post about drawing trendlines:

I'm somewhat confused with your chart and I'm wondering if you can help me understand your methodology better. With that chart, why wouldn't the trendline be drawn from your start point, to the dip that occurred back at the end of November? That line would have had several lows touching, or nearly touching the trendline. It would have exited the trend back in early December and signaled the beginning of a consolidation phase. Also, do you always draw to the bottom of the tail versus the body of a candlestick? Do you have any techniques to help discern what is possibly an aberration in the chart? I’m noticing that many charts would have perfect trendlines with the exception of a candle or two.

Chad is correct in that there is (was) a trendline that went through that late November low. But that trendline was broken on December 7th. I think that whether or not you call what happened next a consolidation is open to interpretation. The S&P made some higher highs during December, which if you follow Vic's rule, require new trendlines to be drawn. I see this situation a lot, and I've posted charts with these continuously fanning out, broken trendlines before. For example, here's the current S&P chart which shows a few broken trendlines as it basically went sideways through December. Also note how the index often retests the broken trendlines from underneath:

I always draw trendlines through the highs and lows of candlesticks. I think that the trendlines should be the same whether you're using bar charts or candlesticks. While the open and close are very important in candlestick charting, trendlines should use the highs and lows.

Having said that, I know that many traders draw trendlines that simply capture the bulk of the action. They may have a few bars that actually break the line(s). Trader Vic certainly wouldn't be happy with those lines but sometimes lines like that may make sense. There's a detailed article about trend lines at StockCharts.com that may be worth reading. Also, Vic's rule certainly isn't the only rule. This article at StreetAuthority.com details a different way to draw a trendline. Still, I think Vic's rule makes the most sense and what I especially like about it is it's not open to interpretation.

I'm not sure about that 'abberation' question but my guess is that you're just seeing what happens when the professional traders (specialists & market makers) go hunting for stops. They'll often push prices through support/resistance, trendlines, moving averages, etc. just to create volume.

P.S. Let me add some more from Trader Vic on trendlines (emphasis is mine):

In analyzing a trend on the charts, the most useful tool is the trendline. One of the biggest mistakes made by amateurs and professionals alike is inconsistently defining and drawing the trendline. To be useful, the trendline must accurately reflect the definition of the trend. The method I have devised is very simple and very consistent. It fits both the definition of a trend and the inferences drawn from Dow Theory pertaining to the elements of a change in trend:

[snip]

For an uptrend within the period of consideration, draw a line from the lowest low, up and to the highest minor low point preceding the highest high so that the line does not pass though prices between the two low points...

[snip]

While this method is quite simple, it is extremely consistent and very accurate. The slope of this trendline is a close approximation of the slope you would get by doing a linear regression analysis on the price data over the same time period. Unlike other methods, it prevents you from drawing a trendline to suit your purposes -- it prevents you from imposing your wish onto the trendline. It also provides the basis to graphically determine when a change of trend has occurred.