It looks so simple when you see it on a chart; a perfectly drawn trend line, illustrating points on a chart, revealing price continuing to move in a certain direction and trajectory. However, similar to many aspects of the skills we need to develop, in order to become proficient and eventually profitable, drawing trend lines correctly isn’t quite as easy as we initially imagine.
Similar to using a standard moving average such as the 200 SMA, trend lines are visible on certain time frames and then no longer apparent on others. For example; we may observe price just breaching the 200 SMA on the 4hr chart, but it’s still some distance away from reaching the same moving average on the daily chart. It’s exactly the same with trend lines; you’ll think you’ve identified a perfect trend on a one hour chart, but it’s just not there on the 4hr, or the daily.
Therefore, as with many aspects of even the most basic forms of technical, indicator based trading methods, we have to identify (and defer to) what’s considered to be the default time frame for most foreign exchange trading methods; the daily time frame. As discussed in many previous articles, the daily and above are considered to be the standard default time frames used by the majority of institutional level traders. Therefore there’s an element of self fulfilment to analysis on this chart. Moreover, if it’s the chart the majority are making their decisions from, then it makes perfect sense to follow the herd, in this instance it’ll be the herd that actually moves our market.
Thehistorical assomptionis that prices trend approximately 30% of the time and stay range bound 70%, we can use trend lines for both trend identification and confirmation, whilst bearing this calculation in mind. In its most simple illustration a trend line is a straight line connecting two (or more) price points, theoretically extending into the future in order to act as a version of a support, or resistance line. Therefore certain properties of analysis, relevant to support and resistance levels, can also be applied to trend lines.
It takes two points to draw a trend line, a third point then confirms the validity of the trend
The accepted wisdom amongst traders, trading all securities and indices, is that we need two points to begin to draw a trend line and a third to confirm it. In theory; the more points we can use to draw the trend line, the more definitive the line and therefore the trend is. It’s important that traders identify the low, or high points of the uptrend, or the downtrend accurately, if not their analysis will be incorrect. As always, with any form of technical analysis; nothing in our Forex trading world is ever certain, an unexpected, fast moving political event, or an economic data release that misses its forecast by some distance, can see a trend line quickly broken.
Uptrend trend lines will have what is called a “positive slope” and can be identified by joining two or more low points. Uptrends reveal that net demand is increasing, whilst price continues to rise. The security’s market condition is therefore considered to be bullish, as there are more buyers than sellers. If price remains above the trend line then we’d consider the trend to be intact. If or when, price breaks below the trend, we’d then consider the line to be broken.
Downtrend trend lines will have what is called a “negative slope” and can be identified by joining two or more high points. Downtrends reveal that net demand is decreasing, whilst price continues to fall. The security’s market condition is therefore considered to be bearish, as there are more sellers than buyers. If price remains below the trend line then we’d consider the trend to be intact. If or when, price breaks above the trend, we’d then consider the line to be broken.
Trend lines can form part of an extremely efficient, yet incredibly simplistic, technical analysis method. Indeed, there are many experienced and highly successful traders, who’ll keep their charts relatively ‘clutter free’ and only use basic techniques such as: the 200 SMA, price action, pivot points and trend lines to make their decisions. Novice traders should perhaps begin their experimentation by attempting to accurately define past tend lines on their daily charts. Not only identifying the various points, but paying close attention to what happened after the line eventually breaks.