Trend lines are one of the most versatile tools you can use in your technical analysis.
It doesn’t matter your style of trading — day trading, swing trading, or even position trading — trend lines can help you analyze the market better.
What is a trend line?
A trend line is a diagonal line that connects two or more price points and then extends into the future to delineate the price trend. In an uptrend, a trend line connects consecutive higher swing lows, while in a downtrend, it connects lower swing highs.
As you would expect, there are two types of trend lines: the upward trend line (or uptrend line) and the downward trend line (downtrend line). Let me show you what they look like:
What can you infer from the charts above? Well, it’s simple: the uptrend line acts like an ascending support level, while the downtrend line acts like a descending resistance level.
How to draw trend lines:
To draw a trend line, simply follow these three easy steps:
STEP#1: Identify the general direction of the price: Look at your chart and check whether the price is rising or descending from left to right. If it is rising, then there is an uptrend, but if it is descending, you have a downtrend. If the price remains around the same range, then there is no trend — the price is said to be range-bound.
STEP#2: Identify the obvious swing points: If you have an uptrend, mark the obvious troughs (swing lows). If you have a downtrend, mark the obvious peaks (swing highs).
STEP#3 (A): Connect a minimum of 2 marked troughs (or swing lows) in an uptrend with a linefrom left to right to get an upward trend line.
STEP#3 (B): Connect a minimum of 2 marked peaks (or highs) in a downtrend with a line to get a downward trend line.
Let me give you an example. See the charts below:
For most beginners, however, the confusion begins when they look at a chart and see too many swing lows or swing highs, and they just cannot figure out which two they should use to use to draw a trend line.
To overcome that problem, you need to understand the significance of the different swing lows or swing highs, and the levels of trend lines that can be drawn with them.
Different levels of trend lines:
When drawing trend lines, you can find that there can be different levels of trend lines:
-The outer trend line is usually the main trend line drawn across the most significant peaks or troughs, which are quite obvious on your chart. Let me give you an example with the charts below:
To avoid confusion when drawing trend lines, the two lows or highs across which the trend line is drawn must be obvious and easy to identify.
You have to focus only on the most significant lows or highs; don’t bother yourself with insignificant levels.
Now, let me give you a practical example:
Look at this chart below. How many significant lows can you find?
I can see 3; can you see them?
Now, let’s assume that you saw this chart when the price just made the second significant low, and you drew an upward trend line connecting those two lows. When the price pulled back again and reversed around that trend line, making that third low, you could have entered a long position with very LOW risk and made a good amount of profit in that trade.
Here is another example. See the chart below :
As you can see from the chart, the lows are very obvious and therefore, easy to spot (significant). When a trend line was applied across the first two lows, it gave a clear uptrend line. Subsequently, when the price retraced to the trend line, we had a nice upward bounce on each occasion.
See the example of a downtrend line in the chart below:
You can see the downward trend line drawn across the most obvious peaks (highs). Those highs can easily be spotted by everyone. Assuming the trend line was drawn when the price made the first two swing highs, you could have entered a short position when the price retested the trend line (the third high). That would have made a good profit.
Valid and invalid trend lines
Here are some points to note:
- A trend line is valid as long as it has not been intersected significantly and the price continues to obey it.
- A trend line becomes invalid when it is intersected significantly, and this could mean that the trend has now probably changed.
So, how can you tell if a trend line is “intersected significantly”, as this may or may not imply a trend line breakout?
Well, there is no exact method to determine that, but here is one thing that I look out for:
#: I check whether the candlestick that intersected the trend line closed significantly beyond it.
In the case of a downward trend line, if the candlestick closes significantly above the trend line, then the downtrend line has been violated. See the chart below:
As you can see, the trend line was valid initially, but once the price rose above the trend line, it was no more valid. At that point, the trend line should be ignored.
The opposite is also true for an upward trend line: if the candlestick closes significantly below it, that may be a sign that the upward trend line has been
violated and the price could be heading downward.
From our discussion so far, you should now know what a trend line is and how to draw it when the market is in an uptrend or a downtrend. But that is not enough: you need to know how to combine it with other market tools to identify good trade setups. You can learn more of such from our free Telegram channel where we share more knowledge. I even give 2 to 3 live Forex signals per week for free.