Trend Lines

What is a trend

A trend is simply, the persistence of a security's price to move in a particular direction. A trend can be bullish, bearish or flat. Also, a trend is in effect till it is reversed. Markets are either bullish, bearish or flat. However markets never go up or down in a straight line. There are always corrections (in bullish markets) and pullbacks or relief rallies (in bearish markets). By identifying trends and reversals, you can enter and exit trends at the correct time and earn excellent profits with minimum risks.

Trend Lines

Trend lines are probably the most common form of technical analysis. They are probably one of the most underutilized ones as well. If drawn correctly, they can be as accurate as any other method. Unfortunately, most traders don't draw them correctly or try to make the line fit the market instead of the other way around. In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys). In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).

Types of Trends

There are three types of trends:

1. Uptrend (higher lows)

1. Downtrend (lower highs)

1. Sideways trends (ranging)  

How to Draw Trend Lines on a Stock Chart ?

Drawing trend lines is an art form that can take awhile to master. That's because everyone has their own unique way of drawing them! There is no perfect way to draw them and it seems that no one can agree on the best way! 

To draw trend lines properly, all you have to do is locate two major tops or bottoms and connect them.

What's next?

Nothing....... is that it?

Yes, it's that simple.

Here are trend lines in action! Look at those waves!

Drawing trend lines
The chart below shows an example of a trend line in a downtrend and an uptrend.

number_1 Shows three swing highs on the downtrend
number_2 Shows three swing lows on the uptrend

When drawing trend lines in a downtrend, you draw them above the price.
You can practice identifying trend lines in the following exercise:

Using the wicks or bodies of the candles, which of the following trend lines is correctly drawn on this downtrend?
number_1

number_2

number_3

Solution

The solution is number_2

Drawing trend lines can be tricky and must be done correctly in order to trade with them. Remember that in a downtrend you always draw trend lines above the candles. In chart number_2 we see price testing as resistance the trend line 3 times.

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.
You can practice identifying trend lines in the following exercise:
At least two swing highs or swing lows are needed to draw a trend line in either direction.
However, for a trend line to be valid, at least three highs or lows should be used. Essentially, the more times the price touches a trend line, the more valid it is, because there are more traders using them as support or resistance.
Using the wicks or bodies of the candles
To draw trend lines, some traders use the bodies of the candlesticks, while others prefer the wicks. While the majority of people will use the wicks to draw trend lines, the use of the bodies is an acceptable way to draw trend lines on a chart.
The chart below shows a trend line drawn using the wicks of the candlestick.

The next chart below shows a trend line drawn using the bodies of the candles. Either of these are acceptable.

Trend lines are subjective, so use what you feel comfortable with. However, it is important not to deviate from the method that you choose.
Using trend lines to trade
There are two predominant 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

Trend line as support or resistance
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.

es1 Short entry after the price finds resistance at the trend line
sl2 Stop loss above the trend line
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.
Trend line break
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.

es1 Short entry after the price broke through the trend line to the downside
sl2 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.

number_1 Price breaks through the trend line to the downside
number_2 Wait for the price to come back to the trend line and find resistance
es3 Once determined that the breakout is true, enter into a short entry
sl4 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, further confirming 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.
Caution using trend line breaks
In order to trade a breakout of a trend line, it is a good idea to wait until a candlestick 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.

number_1 False breakout
In the above chart, the price moved below the trend line. However, it retraced and the candlestick closed above the trend line. If a trader entered as soon as the price broke through, it would have been a losing trade.
Summary
So far, you have learned that ...

• ... 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.

1. Here are some important things to remember about trend lines:

1. It takes at least two tops or bottoms to draw a valid trend line but it takes THREE to confirm a trend line.

1. The STEEPER the trend line you draw, the less reliable it is going to be and the more likely it will break.

1. Like horizontal support and resistance levels, trend lines become stronger the more times they are tested.

1. And most importantly, DO NOT EVER draw trend lines by forcing them to fit the market. If they do not fit right, then that trend line isn't a valid one!

In conclusion...
I have a confession. I don't draw trend lines very often! After you have looked at thousands of charts, you can see them without having to actually draw them in. And I certainly would never buy a stock just because it is hitting a trend line.
They are just a piece of the puzzle.

3 Tips For Trendline Trading

Trendlines are a staple for technical traders that can be used on any currency pair and on any time frame. Follow these 3 easy steps to drawing trend lines which is a powerful tool to time entries and exits of a trade. A trendline is probably the most basic tool in the technical trader’s toolbox. They are easy to understand and can be used in combination with any other tools you might already be using. By definition, a trendline is a line connecting two or more lows or two or more highs, with the lines projected out into the future.Ideally, traders look at these extended lines and trade on prices reacting around them, either trading a bounce of the trendline. So, what can we do to make sure the trendlines that we've drawn are sound?

Tip #1 – Connect Swing Lows to Swing Lows (or Swing Highs to Swing Highs) We want to draw a line connecting either two (or more) swing lows or two (or more) swing highs. For those unfamiliar with the term swing highs/lows, we simply mean the peaks and valleys created with zig zagging prices. Once we connect peaks with other peaks or valleys with other valleys, we want to see the line not being broken by any candle between those two points. Take the examples below.  

Learn : Draw Unbroken Trendlines

In the first image, you will find that we successfully drew a line connecting two swing lows. But, between those two points, the price broke through the line that we drew. This invalidates the trendline.

What we want is what we see in the second image, two swing lows connected together by a line unbroken by price. This is a valid trendline that is ready to be projected out into the future.

Next time price gets near this trendline, we will want to look for a bounce. A convenient way of trading this type of setup is using Entry orders. Entry orders can be set to get you into a trade at a specific price.

I like to set my Entry orders several pips above a support trendline or several pips below a resistance trendline. That way if the price reacts before getting to the trendline, I still have a chance at getting into a trade. You have to remember that if there are many traders looking at the same price to act as support/resistance, there is a chance that orders will be stacked around these levels. If there are enough orders keeping the price from getting to the trendline, the price might not get to you order if it’s placed directly on it.

 

Tip #2 – The More Connecting Points, the Better

 

You've probably noticed that I have referenced two or more highs/lows make up a trendline. The reason I mention "or more" is because trendlines can continue to be relevant far out into the future and can be bounced off of several times. As a general rule of thumb, the more times a trendline has been hit and respected with a bounce, the more important the market believes that it is. Like anything, however, trendlines cannot last forever. So after a multitude of bounces, one has to expect a break to eventually occur.

The first reason this is true is that you can draw a line connecting any two points on a chart. Just because there were two distinct highs in the last 50 bars and you drew a line between them doesn't actually mean the line is a valid trendline. What you would have is a potential trendline.

To truly validate a trendline, you need to see the price actually react from a line projected from a trendline drawn based off of two prior points. Essentially, a third high/low is needed to truly solidify a trendline. Once you have this, you can then feel better about looking for opportunities to exploit the market when price reaches the trendline again. While having a third high/low is recommended before looking for a trade, it is not required. Aiming for an entry on point #3 below could work out just fine.

Learn: Validate Trendlines

 

Each time you see the price bounce off the same line, the more likely it is that others are watching it too and are playing the same game you are. This could help you get several good entries in a row, but remember trendlines won't last forever. So you want to make sure you set proper stop losses to get you out quickly if the support/resistance trendline eventually fails.

Tip #3 – Buy Bullish Trendlines, Sell Bearish Trendlines

 

The trend is your friend! This steadfast rule also applies to trading trendlines. For experienced traders, this basically means we should only look to buy at bullish support lines and sell at bearish resistance lines. For traders not into trading jargon, let the following images below explain this to you.

 

Learn : Buying Bullish Support Trendlines

 

An upward slanting (bullish) trendline means the price has been trending up, so we want to look for buying opportunities. Buying opportunities occur when the price drops down and comes close to the trendline that has caused upward bounces before.

 

Learn : Selling Bearish Resistance Trendlines

 

A downward slanting (bearish) trendline means the price has been trending down, so we want to look for selling opportunities. Selling opportunities occur when the price moves up and comes close to the trendline that has caused downward bounces before.

Trading only in the direction of the trend well let us exploit potential trendline bounces as efficiently as possible. And while they won't always give us winning trades, the trades that are winners should give us more pips than had we been attempting to place trades against the trend.

(Note: There is also the potential to trade a break of a trendline rather than a bounce, but that is a more advanced technique. This is something to be covered in a future article.)

Connecting the Dots

Coming full circle, trendlines are a very simple tool to use. You are connecting dots on a chart. But hopefully the 3 tips above will help you take drawing trendlines to the next level. Make sure that the lines you draw are connecting two or more highs or two or more lows, but have not been broken by the price between those points. Remember to look for at a 3rd bounce to validate a trendline. Also, make sure you are taking advantage of trading with the trend by looking for buys in bullish markets and sells in bearish markets.

Overall, I hope this makes you more confident in drawing trendlines. Good trading!