NASDAQ Abandons Its Trend Channel

09/22/05 07:57:26 AM

by David Penn

Midway through its August journey, the NASDAQ broke through a season's worth of support.

Security: $COMPQ
Position: N/A

I am indebted to colleague and Working-Money.com author Sharon Yamanaka for turning me on to the magic of trend channels (see her Working-Money.com series on William O'Neil's CANSLIM method in "Get The CAN In CANSLIM" from August 22 and "CANSLIM II: The Gold At The End Of The Rainbow" from September 7).

Combining trend channels with the rules for drawing trendlines as described by Victor Sperandeo in his book Methods Of A Wall Street Master (or see my "Trading With Trendlines," Working-Money.com, August 29) gives traders, speculators, and investors an excellent sense of both how strong a trend is as well as how vulnerable a trend is for reversal.

FIGURE 1: NASDAQ. After breaking down below the lower boundary of its multimonth trend channel in late August, the NASDAQ attempts--and fails--to regain the higher ground in September.

Graphic provided by: Prophet Financial, Inc.

To draw the channel, I start with a Sperandeo-styled trendline. This means drawing a line from the lowest low (for the time period under consideration) to the highest low that is immediately before the highest high. Do this without passing through any price bars/candlesticks and you've got not only a perfect trendline, but also a sample of how to draw a perfect trendline every time. This is key. If you develop trading rules that have to do with trendlines, then it is important to draw all trendlines in the same way.

With the NASDAQ, the trend begins in late April and appears to top in earliest August. By mid-August, the NASDAQ has moved down to and through the trendline of that trend. While this alone was not enough in and of itself to confirm a reversal in trend, the violation of the lower boundary of the trend channel was a warning that the NASDAQ's past "angle of ascent" was too steep.

The confirmation of the reversal arrived by mid-September. As shown in Figure 1, what is required for a reversal is first an attempt to reassert the uptrend. This is what the NASDAQ did in the first half of September. If that attempt fails (by, for example, not setting a new high), then the next requirement is for the market to take out the most recent, post-trendline break low. This is precisely what the NASDAQ did in the second half of September.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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