Without a doubt, learning how to draw effective trend lines on our charts is essential. Trend lines provide one of the most highly visible and simple methods for identifying potential trends, which may be emerging in our market place.
However, it’s important that we learn how to identify trends and draw the lines correctly, as one of the most common mistakes traders make, is to see two points on a chart (these could be recent lows or recent highs) and then excitedly join these two dots believing that, once the line is then drawn, it automatically represents a trend.
Identifying trends is often considered to be as much art form, as mathematical science. Also, what actually represents a trend can vary, depending on the opinion of various traders. Certain traders and technical analysis experts, would suggest that no trend lines should be searched for on any time frames below the daily time frame. Others would challenge that theory, by suggesting that you can identify a trend on a lower time frame, such as the one hour time frame and then use higher time frames to observe if the trend pattern continues.
Many traders who use trend lines will be what could be termed “minimalist traders”; they’ll trade off charts and time frames that are mainly decluttered and naked of indicators. Their contention will be that many technical indicators lag, they don’t lead. Therefore trend line traders might typically use a moving average crossover and candlestick price action to identify opportunities, as opposed to using many various technical indicators, such as oscillators.
The relevance of the trend line is often determined by the amount of times price (of the relevant security) touches the trend line, whilst the duration of the trend is also significant. For example; a possible trend line where price bounces off it five times, is more significant and robust than one where price only touches it twice. Trend lines that remain un-breached for two weeks are logically more robustand reliable to make trading decisions from, than a trend line that lasts for four days. And breaks in strong trend lines should be regarded as highly significant and perhaps indicative of a pending market event.
Drawing an uptrend.
During uptrends, trend lines are drawnat the bottom of the chart. We should draw the trend line that precisely connects the lows of the wicks, it should never be an approximation. The trend line then becomes a support line, which in theory, should the trend line remain intact,illustrates that price will unlikely to break the trend line. Instead, price should reject the trend line, what’s termed “bounce off” it.
Drawing a downtrend.
During downtrends, trend lines are drawnat the top of the chart. We should draw the trend line that connects the highs of the wicks. The trend line then becomes a resistance line.
Common mistakes to avoid
• If price breaks the trend line, then that trend line is simply no longer valid. If price continues in the same direction, then a new trend line can be drawn to accommodate the new conditions.
• Occasionally trend lines are significantly breached and a new trend can begin to develop. In this situation we should immediately discard the existing trend line completely,as it is no longer valid. It’s very important thatwe don’t attempt to redraw our trend line, unless the trend is definitely continuing in the same direction.
• Novice traders often draw trend lines through the general direction of the trend, thereby breaking all the accepted rules. Trend lines cannot cross through wicks, we need to precisely identify the recent high and lows, exhibited by the tops and bottoms of the candlestick wicks.
• It’s important that we avoid the mistake of drawing trend lines from left to right or vice versa, we should always start with the current price. The accepted trader wisdom is that it takes at least two tops or bottoms in order to draw valid trend lines, however,it’s considered that it takes three to confirm a solid trend line.
• Avoid drawing steep trend lines as they’ll be less reliable the steeper they are, therefore they’ll be more likely to break.
• Similar to our traditional pivot point horizontal support and resistance levels, trend lines will become ‘stronger’ the more times they are tested.
• We must never draw trend lines by attempting to curve fit them to match market conditions.
