Quick Take
trend lines are drawn at an angle and are used to determine a trend and help make trading decisions.
in an uptrend, trend lines are drawn below the price and in a downtrend, trend lines are drawn above the price.
to draw a trend line in an uptrend, two lows must be connected by a straight line.
to draw a trend line in a downtrend line, two highs must be connected by a straight line.
a trend line should be connected by at least three highs or lows to make it valid.
the more times the price touches the trend line, the more valid it is.
trend lines can be used as support or resistance, in which case you can enter trades when the price touches the trend lines.
another way to trade using trend lines is a trend line break, where the price breaks through the trend line.
What is a trend?
The trend is a primary concept in Technical Analysis and is the overall direction of a market or an asset's price. It comes in 3 types: an uptrend, a downtrend and a sideways trend.
An uptrend is characterised by higher highs and higher lows while a downtrend sees lower highs and lower lows. A sideways or trendless trend shows highs and lows bound within a range and is often called rangebound.
Many traders opt to trade in the same direction as a trend, while contrarians seek to identify reversals or trade against the trend. Uptrends and downtrends occur in all markets, such as stocks, bonds, and forex.
A common way to identify trends is using trendlines, which connect a series of highs (downtrend) or lows (uptrend). Uptrends connect a series of higher lows, creating a support level for future price movements. Downtrends connect a series of lower highs, creating a resistance level for future price movements. In addition to support and resistance, these trendlines show the overall direction of the price trend.
Swing Highs and Lows
The term swing high is used in technical analysis. It refers to a peak reached by an indicator or a security’s price before a decline. A swing high forms when the high reached is greater than a given number of highs positioned around it. A series of consecutively higher swing highs indicates that the given security is in an uptrend. A swing high can occur in a rangebound or trending market. A swing low is the opposite of a swing high.
Trendlines
Trendlines are used to give indications as to the immediate trend and indicate when a trend has changed. They can also be used as support and resistance and provide opportunities to open and close positions.
Shows three swing highs on the downtrend
Shows three swing lows on the uptrend
When drawing trend lines in a downtrend, you draw them above the price.
When you draw trend lines in an uptrend, you draw them below the price. It is the highs on a downtrend and the lows on an uptrend that will determine a trend line.
At least two swing highs or swing lows are needed to draw a trend line in either direction. For a trend line to be valid, at least three highs or lows should be used: the more times the price touches a trend line, the stronger it is because there are more traders using them as support or resistance.
Using Trendlines to Trade
There are two main methods in which to trade using trend lines:
Entering when the price finds support or resistance at the trend line
Entering when the price breaks through the trend line
If a trend line has been identified and it is holding as support or resistance, then you can use the trend line to enter into the market once the price comes back to it.
The chart above shows the trend line being used as resistance and the price using it to find an entry. A stop loss can be put on the other side of the trend line. The size of the stop loss depends on the strategy involved.
There are indicators available that will automatically draw trendlines for you but in reality, drawing trendlines is a manual exercise. Trendlines are static - they don't change with volatility or respond quickly to market conditions. Therefore some traders opt to use moving averages to identify trend in a dynamic way (see below).
The trend line break method uses the actual breakout of the line to determine an entry. When the price breaks through a trend line, it is no longer valid as support or resistance and it is likely that the price will continue to reverse direction. There are two ways to enter using a trend line break: an aggressive entry and a conservative entry.
An aggressive entry
An aggressive way to enter using a trend line break is to enter as soon as the candle breaks through and closes on the other side of the trend line.
Short entry after the price broke through the trend line to the downside
Stop loss is placed above the trend line
The chart above demonstrates that once the candle closes on the other side of the trend line, then you can enter immediately. A stop loss can be placed on the other side of the trend line.
A conservative entry
A more conservative way of trading the trend line break is to wait until the price has broken through the trend line and then tested from the other side as either support or resistance.
Price breaks through the trend line to the downside
Wait for the price to come back to the trend line and find resistance
Once determined that the breakout is true, enter into a short entry
Stop loss is placed above the trend line
The chart above shows a trend line that has been broken after acting as support. The price then tested it from the other side as resistance which confirms that the breakout is likely to continue. After the trend line has been tested as resistance, you can enter a short position and place a stop loss on the other side of the trend line.
In order to trade a breakout of a trend line, it is a good idea to wait until a candlestick (bar) actually closes on the other side, or tests the other side of the trend line as either support or resistance. Without a close on the other side of the trend line, it is generally not considered an actual break.
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