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Why do we look at a price chart when trading? The price chart reveals the price change of a financial instrument. When values are plotted across a time frame, we tend to see patterns. The value of a financial asset does not shoot up on a straight incline. Charts feature peaks and troughs. There are pullbacks and runs.
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Prices can be trending upwards and downwards. The purpose of drawing trend lines is to reveal what is proceeding. And remember, the market consists of buyers and sellers. The presence of many buyers pushes up the cost of a financial instrument. If many sellers enter the market, prices are driven down because of an influx.
How to Draw a Trend Line – Practical Guide
We begin with a blank AUD/CAD daily price chart. It’s recommended that you use a candlestick pattern chart.
Step 1: Visualise the Peaks and Troughs
The first step is not necessary when drawing a trendline. But it can help when visualizing how the peaks and troughs form. Just connect several rising peaks and bottoms. Note that you don’t have to get perfect-looking shapes. This quick trick acts as a visual guide to see how the market is trending.
You can even take a screenshot of the chart and plot using a pen tool on Paint. Our roughly drawn sketch looks like this:
How do you identify a trend line? Well, see the second step.
Step 2: Identify If You Have an Up- or Downtrend.
If you used our quick shortcut in step 1, you might tell how the market is behaving. The trend line is one continuous straight line. It connects several high or low points in the chart. For instance, here is a trendline revealing the formation of an uptrend:
The consecutive swing lows are higher than the previous ones. The trendline has a positive slope.
One of the rules when drawing a trend line is to find two points first. It should preferably pass through a third point. Any part of the candlestick wick can cross the trend line, but preferably the body should remain above it. The figure above shows that the trend line touched several candlesticks that were higher swing lows.
Note that the strongest trendlines have several touching points. You can also add more Forex trend lines on the same chart.
For instance, we have added more valid trend lines, but the chart has started looking messy.
It’s advisable to keep the chart as neat as possible. But you can draw several lines at first to find the strongest and clearest trends.
Drawing a Line for a Downward Trend
We have covered how to draw a trend line for an upward trend by connecting consecutive higher swing lows. When drawing a downward one, we check if a consecutive swing high is lower than the previous swing high. Now, here is a daily chart for the BTC/USD with no trend lines:
Next, we plot the significant pullbacks and runs (you can do this off the chart).
Drawing a downward line requires connecting consecutive lower swing highs as follows.
Types of Trend Lines
The types of trendlines depend on market conditions. You can have only three market conditions producing three lines:
- Downtrend line – Results from connecting consecutive lower swing highs or lower lows.
- Uptrend line – Derived by connecting higher swing highs or higher swing lows.
- Ranging market – The ranging market gives us a third type. Here the market movement looks horizontal, and the trend line will not have a significant negative or positive slope.
Other Types of Trend Lines Depending on How They Are Drawn
The textbook way of drawing a trendline involves having it touch the outermost points of a candlestick wick. Ideally, it does not cross above the price action. When the price action crosses the trend line, it becomes invalid if a reversal has occurred.
But it’s possible to draw a double-sided trendline that connects points from both sides of the price action as follows:
Note that your trend lines don’t have to match the textbook version. They just have to identify the presence of an up- or downtrend. And you can even do this without ever drawing a trendline in the first place.
Guidelines to Follow When Drawing a Trend Line
- Trend lines with very steep slopes are generally unsustainable, so they tend to be short-lived.
- It’s critical to have at least two points touching the trendline, and the third point further adds clarity.
- It’s advisable to draw them on a higher time frame, such as one day, 4 hours, 1 hour, 30 minutes, or 15 minutes.
- The price action can negatively invalidate trend lines. But it’s possible to have fakeouts (when the price action tests and crosses the trend line only to conform to it).
- Smart traders keep adjusting their trend lines to reflect the dynamic price action.
- The more the number of touches, the more a trendline is considered valid and significant.
- Once you enter a trade, it’s not recommended that you keep moving the trend line just to reflect how you wish to trade.
- Do not attempt to fix trendlines so that they conform to the pattern you want.
Common Trendlines Trading Strategies
What is the best trendline trading strategy? Well, the best trading strategy is one that tells you when to open and exit positions. It should also specify the rules for setting stop-loss and take profit.
The last key component of an excellent trendline strategy is one that relies on other indicators and patterns for confirmation.
Here is an overview of two common trend line trading strategies. We have attempted to provide an overview of how they work. And this doesn’t constitute trading advice.
Breakout Trend Line Trading Strategy Overview
What happens during a breakout? The price stops conforming to the resistance level set by a downward trend line or the support offered by an upward one. If you’re going to set up a breakout strategy, you will also need skills to identify a false breakout.
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Let’s apply the trendline breakout concept by looking at an example using the AUD/CAD daily chart:
In the following price chart, we have drawn a line connecting two points. It touches the third point before the price action moves under the trendline. You may face this situation in real life.
The money question is: Will the prices continue trending downwards to form a new trend, or will the prices rally back and continue following the uptrend? Because we are not sure how to proceed here, let’s carry out another analysis. We’ll look at a higher time frame, which is the monthly chart.
Trendline 1 reveals a prior downtrend before a reversal occurred, as indicated by trendline 2 (our current one).
Your analysis does not stop here. You should also look at a lower time frame, which is the 4-hour or one-hour chart to see what’s currently happening in the market.
The price retested the trend line twice before continuing to trend downwards. And in fact, several candlesticks closed below the trend line.
When validating trend breakouts, you can use other indicators. As an additional research assignment, learn about validating breakouts.
Bounce Trendline Trading Strategy
The trendline bounce strategy involves using the trendline as an area of support or resistance. Traders using this style count on the price testing the trendline but never breaking through it.
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Instead, the price bounces to and from the trend line. For instance, a trader using this strategy may buy when the price action falls towards an upward trend line, as illustrated below:
During a downward trend, traders using this strategy will sell when the price rises to touch a downward line. It looks like this:
Trading With Trend Lines Only: Is It Advisable?
We have generally introduced using trend lines in trading. Some of the popular trading strategies that incorporate trendlines don’t rely on them exclusively.
The most effective approach is combining them with candlestick patterns such as the bullish engulfing pattern, morning and evening stars, etc. Also, use technical indicators and other on chart analysis tools such as Fibonacci retracement lines. Trend lines can also be incorporated into a Forex strategy.
Some Frequently Asked Questions
- Why are trend lines used?
They produce reliable support and resistance levels. They can reveal a loss or increase in momentum. You can use them to predict future price movements, and for this, it’s advisable to draw them as ray lines.
- When drawing a trend line, how many periods are required?
The number of periods you will use to draw your trend line will depend on your trading strategy. It’s much better to understand how trading strategies work and formulate some on your own.
Some traders may specify that they’re trading lines have to be about 40 candlesticks long, 30 candlesticks long, etc. So, a trendline may span several hours, weeks, or months depending on the time frame used and its length.
- How to draw trend lines of technical analysis?
Well, connect consecutive swing lows or swing highs and check if the line’s slope is negative or positive.
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