One of the most essential tools used in technical analysis for stocks is trendlines. With these markers, you can better understand whether a company is trending up or down in the stock market. Most online brokers allow you to perform chart analysis with trend lines within a few clicks.
Trends can be bullish (increase, uptrend) or bearish (decrease, downtrend). A newer high is formed when a currency pair gets higher than the previous high. A new minimum is formed when the price gets lower than the previous minimum. The higher highs and higher lows mean it is an uptrend. The lower highs and lows point to the downtrend.
What are trend lines?
A trend line can be defined as a straight connection between several points on the chart. The trader lets them extend over several price levels. A general trend becomes clear through this form of chart analysis. The whole thing can be combined with the support and resistance levels. Read more about support and resistance in a separate article.
To mark an uptrend line or a downtrend line, create a connection between the lows and highs. This makes the price development clear, and you can make out a rough direction. Especially when you zoom out from the hourly and daily charts, you get a holistic picture of the trend channels.
The trend lines are essential in order to put the short-term price fluctuations in the context of the general price developments. So downward or upward trends do not go linearly in one direction but rather move forward in waves.
Such formations are called Elliott Waves in technical analysis. The identification of trading signs is possible in a few steps. With such a signal, you should then start trading in one direction or the other.
How to draw trend lines correctly?
Trendlines are one of the most popular technical analysis tools. Pay attention to this tool for other, more complicated instruments because the trend lines can benefit your trading.
The main advantage of trendlines is that they make the chart easier to understand. To be successful in trading, you should find important information on the chart, separate it from useless information and project it into the future. Analysis of the trend line helps to find more and thus make correct trading decisions.
You can draw many trend lines on a chart, but you need more lines to be clear to you. The goal is to choose and draw the most obvious line. When a trendline is evident, many traders, including the big gamblers, will notice it. Thus, the chances that the line will sustain the movement of a currency pair become higher.
A trendline has two characteristics:
- At least 2 intersections with the course.
- Bias (the line is not horizontal).
The more intersections, the stronger the trend. Notice the angle of the trendline. The trend is too strong and unstable if the angle is less than 30 degrees.
It is better if the angle exceeds 45 degrees. In other words, the second point through which we draw the trend line should be 20-30 candlesticks apart from the first.
Sometimes you can clone the trend line and move it, so the cloned line goes parallel to the first one and limits the trend from the other side. This line goes through the pair’s highs, and the other connects the lows. It’s called a trend channel.
Note that the main line in the uptrend is the line connecting the lows (a support line), but in the downtrend, it is the line connecting the highs (a resistance line). The channels help retailers to orientate themselves to the trend.
The logic of trend trading
In the case of an up/down trend, it is recommended to open positions in the direction of the trend. As the dealers say, a fiend is your friend. In other words, the chances of that increase when the pair hits the support line on an uptrend. Buying on the uptrend and selling on the downtrend is called trend trading.
The goal is to enter the trend early in order to get the maximum profit from trend trading. Consider the following courses of action:
- Determine the trend using price action and technical indicators
- Plan your entry – Buying on the recoil of support is less risky than buying on the break of resistance.
- Limit losses.
- Determine the target – take profit should exceed stop loss.
Remember that trading against the trend is riskier and requires professional skills and great experience.
How do we know when the trend line is broken?
If the currency pair is below the support line in an uptrend, it is better if the break is confirmed with one of the following conditions:
- The price ends 1% below the support broken by the trendline.
- Trading volume – when data is available – is above average.
- The following candles end below the line.
After the downside break, there is a rally on the intraday chart back to the broken line here, successfully playing the role of resistance. Such rallies give more stable sell signals when created during times when the volume is average
Risk management in trend trading
Trend trading is a bet that prices will move in a specific direction. If the bet is not successful, there is no point in the deal, so trend traders usually have small stop-loss orders.
- You can quickly move stop loss to the breakeven point.
- You can use scaling in (in the early stages) and scaling out (in the later stages of the trend).
- The risk-reward ratio should start from 1:2.