Investors who read stock charts can use moving averages, price action and volume signals to sell stocks. Add to that toolbox a simple straight line.
If a stock breaks its long-term price trend, that's as good a reason to sell as any. But of course it can't be just any straight line. We're talking about a trendline connecting the lows along a stock's advance. Once shares break below the line, the thinking goes, the stock is most likely headed much lower.
But how long should the line be? How many lows should it touch? Glad you asked.
In his book "How to Make Money in Stocks," IBD founder William O'Neil spelled out the framework of a proper trendline violation.
Trendlines Using Stock Charts
The upward-slanting line should touch at least three intraweek or intraday lows on stock charts. Those lows should span more than four months. According to IBD's Chart School, the minimum length is 18 weeks.
The more lows the line touches, the more reliable it is. Also, it's best to use weekly charts with algorithmic price scales, which do a better job expressing stock moves on a percentage basis.
If the stock breaks below the line in heavy volume and closes the week below it, that's your signal to take profits.
In a variation of this principle, sellers also can look for breaks of support, i.e., a series of persistent lows at a certain price level. This is the same idea, except that the stock pierces a horizontal level rather than an upward price trend.
Breaking Support In Charts
Generac Holdings in 2022 provided a good example of using trendlines with stock charts.
The maker of electric backup generators made a tremendous run from a breakout to new highs in June 2019 to the autumn of 2021.
Using weekly stock charts, investors could draw a trendline that neatly touched distinct lows in December 2020 (1), May 2021 (2) and October 2021 (3). The next touch came November 2021.
Then, on the week ending Dec. 3, Generac slid 11% in weekly volume that was 44% higher than average (4). The stock closed about 12% below the trendline, and the sell signal was seared into the stock chart. Generac would collapse about 50% from the signal to a low in May 2022.
Such dramatic breaks of support often come with other sell signals, and that was the case with Generac.
The stock also broke below the 10-week moving average in heavy volume the same week of the trendline violation (4). A few weeks earlier, Generac had broken out of a late-stage base (5) — remember, the stock had been steaming higher for more than two years — and quickly made a bearish price reversal.
