Trend lines are probably the most simplest of all methods when it comes to trading with price action. A trend line simply shows you what the current trend is. Depending on the time frame that you choose, the trend lines can differ. There are just two types of trend lines. A falling trend line which depicts the downtrend or the bear market and a rising trend line which depicts the rising trend line in an uptrend or in a bull market.
It is important to note that trend lines can change depending on the chart time frame. For example, if the trend on an intraday chart is down, you would most likely be plotting a falling trend. However, if you switch to a higher time frame and depending on the bigger trend, you could plot a rising or even a falling trend line. This can get a bit confusing especially if you are new to trading; having said that, trend lines are simple and easy to understand.The biggest advantage of using a trend line is that you can combine it with price action methods, or you can use the trend lines in conjunction with technical indicators as well.
In this article, we explore in detail about trend lines and how to draw a trend line. There are many technical indicators that claim to plot a trend line automatically. While it might seem easy to use these automated trend line drawing indicators, nothing beats the fact that drawing trend lines by hand is a better approach. It is also important to understand that the concept of trend lines can change based on one perception to another. Thus, there is some objectivity involved. But do not get too bogged down by these minor details as the larger concept (the trend) is still relevant.
What is the Purpose of Drawing a Trend Line?
The purpose of drawing a trendline is to ascertain whether the current will continue in the same direction or if the trend can change. Most traders make the mistake that a broken trend line means a change of trend. This is partially true. But, the important point to note here is that a broken trend line could simply mean a deeper retracement or a pullback to the trend, or it could indeed signal a change of trend.
This is where trend lines can help. By understanding trends, you can easily take the help of trend lines and figure out what prices are doing. Trend lines can be traded in two ways. You can either trade the break of a trend line, or you could wait for the retracement to be completed and enter in the direction of a trend.
Thus, trend lines can help you to either trade in the direction of a trend, or trade a counter-trend move or a retracement. The key point to success with trend line trading is in knowing how to plot the trend line.
The Importance of a Trend line
Trend lines are important as it can give you the larger context of the market. To put it in simple terms, trend lines can tell you whether the current trend has ended. Then, you can look at the larger view and understand if this change of trend is temporary or if a new trend has been established. This knowledge comes from firstly understanding what trend trading is. You can refer to this article to get to know all about trend trading. Then, you can apply that knowledge to the concept of trend line trading to better your odds of making more successful trades.
A trend line is typically at an angle of 45 degrees. But in reality this is not always the case. Similarly, some believe that trend lines should have at least three contact points. But again this is a text book example and real life trading seldom aligns itself to the best examples. Therefore experience and practice will be your best guide in plotting trend lines.
How to Draw a Trend Line for Uptrend and Downtrend?
Assuming that you have read the previous article about trend trading, we already know that in an uptrend, price makes higher highs and higher lows. Similarly, in a downtrend, price will make lower highs and lower lows.
In an uptrend, you would be focusing on the higher lower. Then, connecting these higher lows you can draw the rising trend line. When this rising trend line is breached, you can expect to see a retracement or a change in trend. In a downtrend, your focus would be on the lower highs. Connecting the subsequent lower highs, you would draw a falling trend line. When this falling trend line is breached, you will then know that prices are changing the trend or simply making a retracement.
In figure 1, we have a rising trend line example. The higher lows highlighted are the levels that we use to connect. Here, we make use of two higher lows to plot the trend line. This becomes our reference for the uptrend. When price breaks this rising trend line, we can know that the trend is changing. Traders typically look for the break of the trend line and use the opportunity to trade the short term retracement or a trend change.
Figure 1: Plotting a rising trend line
In a downtrend, you would use the lower highs to plot the falling trend line. When this falling trend line is broken, you can then expect to see a short term reversal, thus going long on the market. The next chart in Figure 2 illustrates a falling trend line.
Figure 2: Plotting a falling trend line
In the above example, you can see the falling trend line forming after the two lower highs are used as the reference point. Once the falling trend line is breached you can see how quickly price changes the trend, rising rapidly. The most important part about trend line trading is the break out of the trend line itself. This will give lot of trading opportunities. Day traders use the trend line break out method in order to enter the direction of the break out which will give some quick profits.
Trading the Rising and Falling Trend Line Breakout
The most common way to trade the rising trend line is to wait for price to break this trend line. When this occurs, traders sell into the breakout level and set the initial target to the most nearest higher low (which is the second higher low in the above example). The stop loss in this case is placed at the recent higher high that formed just before the trend line breakout. As you can see in the above example, the stops would be placed at the recent highest high that was formed prior to the breakout of the rising trend line.
With a falling trend line, you would be buying the break out of the trend line. When a falling trend line is breached, price moves in the opposite direction, thus warranting a long position. Similar to a rising trend line, your entry would be at the breakout of the trend line. Stops would be placed at the recent lows while the initial target would be the immediate lower high that was used for plotting the falling trend line.
Why Trade with trend lines?
Trend line trading can be very beneficial but comes at the cost of getting familiar with this method of trading. Trend line trading can be combined with other technical indicators such as moving averages in order to confirm the change of trend. With trend lines, you can easily trade with the trend and be alerted as to a possible change of trend whenever there is a break to the trend line. There are many trading opportunities that can be created with trend lines. While it might seem a bit subjective, with enough practice traders can trade the trend lines with confidence.
The post What is a Trend Line? appeared first on Advanced Forex Strategies.
from Advanced Forex Strategies
