One of the benefits of technical analysis is the ability for technicians to project price. This enables us to know the likely extent of a move once a pattern has completed, or in this case, once a trendline has been broken. Today we’re going to cover the method for calculating a price projection from a broken trendline.
The calculation is rather simple. You must start with the required characteristics of trend to begin. You must be analyzing a stock that was in a confirmed uptrend (at least two touches, but three or more is best) that is broad enough in its range to analyze. If the price bounces along the line without rallying a significant distance off of the line, this method will not work. It is best to see a trend channel with a wide range of that channel, as narrow ranges will not work. Again this is subjective, so use your best judgment, and you will see why this is important. And of course, the trend must actually have been broken to realize a projection.
Below is a recent daily chart of BAC with a broken trendline. You can see it has a range of a couple dollars, which is more than 20% on a relative basis, and is sufficient for analysis.
Below are the steps required to calculate:
1.) Determine the high of the move. In this case it is $10.
2.) Next, draw or eyeball a straight line immediately down from the high through the air pocket to the bottom trendline.
3.) From this intersection look right to determine the price level along the Y-axis, then subtract the distance. In this case, $10 – $8.50 gives $1.50
4.) Subjtract the projection from where the breakout occurs. Note it is where the breakout actually occurs ($9.25), not from the intersection ($8.50)
5.) This gives a minimum projection of $7.75. While there is no “maximum” projection, a good rule of thumb is to use 1-2 times the price calculation for your projection. In this case $7.75 to $6.25 (2 times $1.50 from $9.25).
This can be done for any length of trend, but will be more effective for longer-term trends. This can be a useful technique to determine where to exit positions in the direction of the broken trend, or when to become alerted to re-entry below/above the price target.
Note: This information is covered in Martin Pring’s book, Technical Analysis Explained.