This brings us to another interesting use of the trendline—the fan principle. (See Figures 4.11a-c.) Sometimes after the violation of an up trendline, prices will decline a bit before rallying back to the bottom of the old up trendline (now a resistance line). In Figure 4.11a, notice how prices rallied to but failed to penetrate line 1. A
Figure 4.11a Example of the fan principle. The breaking of the third trendline signals the reversal of a trend. Notice also that the broken trend-lines 1 and 2 often become resistance lines.
Figure 4.11b The fan principle at a bottom. The breaking of the third trendline signals the upside trend reversal. The previously broken trendlines (1 and 2) often become support levels.
second trendline (line 2) can now be drawn, which is also broken. After another failed rally attempt, a third line is drawn (line 3). The breaking of that third trendline is usually an indication that prices are headed lower. In Figure 4.11b, the breaking of the third down trendline (line 3) constitutes a new uptrend signal. Notice in these examples how previously broken support lines became resistance and resistance lines became support. The term "fan principle" derives from the appearance of the lines that gradually flatten out, resembling a fan. The important point to remember here is that the breaking of the third line is the valid trend reversal signal.
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