The single most helpful habit for reading charts properly is to stick to the basics. For example, an uptrend requires that price make higher highs and higher lows, and a downtrend that it make lower highs and lower lows. False breakouts are among the most reliable signals - if you can figure out when a false breakout has occurred. There is no more basic technique than drawing trend lines on a chart. However, even in drawing trend lines there is a certain amount of art, or in our view just common sense. Classically, trend lines are supposed to be drawn across the highest or lowest price points. In an uptrending stock the line should be drawn under at least the two lowest prices, and in a downtrend on top of at least the two highest prices. Doing this mechanically, however, without considering the reality of what price has been doing, can lead to drawing inaccurate trendlines that are meaningless for any purpose.

In this issue we will explore a recent chart on the Dow Jones Industrial Average (INDU) and see how if lends itself to different trend interpretations and of course give you our take on it. First, let's look at a recent daily chart of the INDU. The INDU rebounded from a 7416 low in March 2003 and was in a strong uptrend through February 2004, then began the current decline. First of all, this market is in a downtrend, because until point 7, it was making lower highs and lower lows. The low at Point 7 was a bit higher than the one at Point 5, but every succeeding high since the February market top has been lower than the ones preceding it. Calling it a ranging market would be extremely optimistic in my view, because lower lows and highs are not characteristics of a ranging market. The trend is down. It's not a hard downtrend and keeps fighting back up, but trends can be anything from very gentle to almost vertical.

Before I even get to the trend lines, note the bearish divergences in volume. Recent volume trends have been down, even recently when the INDU made five highs in a row. Not too convincing, is it? Look how much of the price uptrend in March and April occured on declining volume. Well, it's summer in an election year, so no one is expecting much strength in the market until September. But remember that one can't just evaluate the price action. Volume is a very strong confirming signal. Uptrending price should occur on increasing volume, and vice versa.

On the above chart I've drawn the trend line across the two highest price points, just as the books say to do it. Note that Points 1, 3 and 4 never even got back to the trend line drawn. More to the point, the most recent closing price today was far below the "trend line." But within the trend drawn according to the charting books, is there an internal trend line that is more meaningful - in effect, the real trend? Let's look at the same chart with the trend line drawn to more closely match the battles the market has won and lost.

This trend line makes more sense in light of actual price action. Note how the line is drawn across the intermediate highs at Points 3 and 4. The next interaction of price and trend line occurs at Point A, when price is falling and holding the trend line. Price then advances to Point B (but can't even get back to Point 4) but loses steam and then declines again to Point C. Was this run up to Point B a false breakout? It was indeed, IF my trend line is the dominant trend. At Point C price cannot even stay above the trend line, and in fact can only make a couple of closes above it, barely above it. Price declines heavily again and recovers to Point D, but again cannot get above the trend line. In other words, drawing the line as I have done indicates that the run up to Point B was a false breakout that the market couldn't sustain. Well, no wonder. Summer is a very weak time for the market. A lot of people are preoccupied with other things, like the elections and the Iraq war.

Fundamentalists (the traders, not the church-goers) would say I'm just drawing lines where it suits me, to make the chart come out "right." But have I, really? Doesn't the new trend line better reflect price action? Always remember that absolute price tops and bottoms can be deceptive, because price will test support and resistance levels. The absolute bottoms or tops reached by price during a test frequently don't matter. The chartist essentially is looking for the consensus number. That is, if a stock hits a certain level several times, one dip below or tick above that test the level may not be meaningful at all.

Example: a stock's price trades down to the $20 level on several days and one day briefly touches $18 and comes back to close at $20. The technician should ignore the $18 level in this example, because it is largely meaningless. Yes, price was beaten briefly to $18, but that really was a test of the true $20 resistance level, which is where the trend line should be drawn.

Volume and the number of times price touches a particular point are the real determinants. Unless an absolute low or high is confirmed by heavy volume or multiple touches, it usually is not as significant as a different level reached several times. In other words, don't be distracted by testing price action, or your trend lines will be in the wrong places.

Is my trend line better? I think it is. At the very least, I've captured the real essence of the market's movement. It is a perfectly valid practice to draw internal trend lines (which mine really is), and they often are much more revealing about true direction and the true chart pattern forming than trend lines drawn according to the book. Put differently, sometimes the "book" trend line exalts form over substance. Ask yourself this: which trend line tells you more: mine or the "book line? So when drawing trend lines according to Hoyle, draw an internal trend line, also. You may be amazed by what you see.

How did I find my trend line? Easy, I started a trend line at the point the price went over the cliff in February and simply moved the line around. I started with the "book" trend line, but instantly saw that it told me nothing and added nothing to my understanding of the price bars. Moving the line further down, across the two intermediate tops at Points 3 and 4, really opened my eyes. I saw instantly that this trend line is the true battleground. Look how many times price has touched or nearly touched my trend line. Does anyone really believe this line is a lucky artifact? By contrast, how significant is the classic trend line, and what does it add to the technician's understanding of the chart?

What would change my mind? The only thing that would convince me the "classic" trend line is the real trend would be for price to advance to the classic line and test it. Whether it pulled back or broke through wouldn't matter in evaluating which is the true trend, because a test at the classic line would be convincing that it is the dominant trend - and the longer and harder the test, the more convincing. If the classic line is the dominant trend then the advance to Point B was not a failed breakout but simply price establishing the trend line.

What's next? I still can't tell you, especially in the midst of the summer doldrums, if the market is headed back up or if it's headed down even further. My guess is it is headed back up, but I won't be convinced until my trend line is broken to the upside on up volume. Note how the recent five days of up closes in a row still didn't result in a single close above my trend line.

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