When somebody is new to technical analysis, one of the first things they learn is how to draw trend lines and with good reason for they are used by virtually every trader in all markets. The difficulties with trendlines is that identifying and drawing the trend can become a largely subjective.
Give two traders identical charts and ask them to draw in trendlines and you will get different results, two separate interpretations. Ultimately, there is only one correct trendline and price action will confirm it. Considering that most traders place orders based on trends, trend analysis becomes the foundation of successful traders.
Price action occurs due to the fluctuation of supply and demand. Traders make decisions based on current price and the prices of the past. The bulls, recognizing the value, drive up price and the bears satisfy the orders, causing the price to go down. Now more buyers see the potential for profits and drive up the price again. With more demand than supply, prices go even further until more sellers are pulled into the market to drive down the price. These collective buying and selling decisions create a market psychology and is in fact the trend, the support and the resistance.
A trendline is essentially a graphical representation of market psychology. It simultaneously provides support, resistance and projection of price action.
Thomas DeMark, author of “The New Science of Technical Analysis” developed Tom DeMark Trendlines in an effort to bypass the subjectivity of traditional trend analysis and to provide a mechanical method for objectively plotting the trend.
The classic method of drawing a downtrend involves identifying the most recent major highs and intersecting them with a line. The opposite is used to draw the uptrend. With this method, one would more or less have to gauge the best angle for the trend line. This introduces a variable where exactitude is desired with technical analysis chart patterns.
Tom DeMark trendlines are drawn by intersecting the two most recent swings. The swings require a little bit of explaining. Now imagine that we have a pendulum that defies physics. It swings left to right even if we place it on its side. In this scenario the pendulum is now swinging up and down. Now, if we pushed this pendulum along a table, the up-down movements would approximate the price action we see on the chart. These are the swings.
An upswing point (candle) is identified as such when it is higher than the candle to its immediate left and its immediate right. That swing point is drawn back (to the left) to the next immediate higher swing point. With these two points connected, the line is further extended (left to right) with a dotted line to show the potential trend. This is how you draw TD supply line (downtrend). The exact opposite is used to draw the TD command line (uptrend).
With this method there is no subjectivity as to where exactly the line should be drawn. It is completely mechanical and eliminates the variables that are introduced with the traditional method. With every swing of the pendulum a new trendline can be drawn. Price action will either validate a trendline or break it. It is important to note that no matter which way price action is ultimately trending, both trendlines should be drawn as they provide insight into price action.
Another famous DeMark indicator is the Tom DeMark Sequential. Early on, Tom DeMark recognized that most investors traded with the trend. If the trend is your friend then reversal in your enemy and not wanting to be caught off guard, he needed a way to anticipate them. Frustrated with the conventional methodologies used to identify market tops and bottoms, Tom DeMark set to work in developing an indicator that would identify market exhaustion. Despite being described as such, The Sequential is by no means, simple. It is, in fact, quite lengthy and tedious, but the reward is a method that is surprisingly accurate in identifying a market top or bottom.
The Sequential is termed as such because there is sequence of phases that must occur in order to generate a buy or sell signal. The first phase is known as The Setup and it involves the counting of nine closes that are all either above or below the close four days prior to the first. Only after The Setup occurs can the next phase take place. That is known as The Countdown. Depending on whether it is a buy setup or a sell setup, a countdown of 13 closes that either above or below the close two days prior are required. There are also conditional rules that can reset both The Setup phase and The Countdown phase. Once The Countdown phase completes, there are techniques for entering the trade.
Looking over all that is required, you can tell that it is something that doesn’t occur too frequently. In fact, it could take months for the TD Sequential to complete on a daily chart, but results of 70% to 90% accuracy have been reported. With such recommendations, every trader should at least give The Sequential a “once over” twice.
For indepth training on DeMark Indicators I highly recommend this technical analysis course.