The simplest formations to recognize are the most commonly used and most important: horizontal support and resistance lines, bullish and bearish support and resistance lines, and channels. Proper use of these basic lines is essential for identifying the overall direction of the market and how it gets there. An understanding of these patterns will be helpful to computer-oriented analysts, many of whose techniques have been modeled after chart formation. More complex formations are likely to enhance good performance but cannot compensate for poor trend identification.
Once the support and resistance lines have been drawn, a price penetration of those lines creates the basic trend signal. The bullish support line defines the upward trend, and the bearish resistance line denotes the downward one. For long-term charts and major trends this is often sufficient, but frequent small penetrations of both long- and shortterm trendlines can be avoided by placing a band around both lines. A short signal occurs when both the trendline and the band have been penetrated. Because of the basic charting rule—-~’Once broken, a resistance level becomes a support level and a support level becomes a resistance level”-the original trendline (or a trendline plus and minus a band) can be used as a stop-loss. If prices penetrate the stop-loss point, then return to the original formation., there has been a false breakout and the original trendlines are still valid.