Lesson

Trendlines in Technical Analysis

In trading, trend lines are used to estimate the broad direction of a particular market. By plotting several contact points on price action over time, traders can gauge not only the likely future direction of prices, but also to pick out prudent entry/exit points for their intended trade.

A plotted trend line is a bounding line for price action in a market. Therefore, the more points with which to plot a line, the stronger the confidence behind the trend. A trend line can be said to exist when a diagonal line is drawn between a minimum of three or more price pivot points.

As a rule of thumb, traders prefer to see at least 3 points of contact before plotting a trend line. The more contact points a trend line has, the greater the confidence a trader has when the price action finally meets it.

Trend lines can also be drawn during downtrends.

Combinations of trends

As is often the case in a real trading environment, the price action of any market can settle into a primary trend, but recoil to transient moves against the prevailing trend.

By identifying a combination of weak short-term trends amid a strong long-term trend, traders can find useful entry and exit points.

Traders can also seek out weak consolidation phases and apply trendlines to those price movements. The sharp bounce in price action (shown in blue) during the prevailing downtrend indicates that the consolidation does not have a high chance of turning into a sustained bullish reversal.

In this instance, traders are better off looking for shorts as price action undergoes short stints of buying interest, rather than initiating longs at or close to the trend line (shown in red).

Tail or body?

A key consideration for traders using trend lines is whether to plot a line according to the candlestick wick (also known as a “tail”) or the candlestick body.

Depending on the market and depending on the trading strategy, traders can choose to use either method. Experimenting with both approaches over time and building up relevant experience in specific markets is recommended.

Bear in mind, there are no fixed rules regarding trend lines – they are a technical tool with specific, almost scientific, application methods. However, trend lines also include an element of artistry and creativity. In general, technical analysis is about spotting consistent patterns while trend lines seek to detect broad directions of price action over time. By experimenting with various plotting techniques, traders can find the most effective way of spotting market tendencies, confluence and reversals.

However, consistency is also important. Therefore, traders are advised to pick an approach that suits their trading strategy and to maintain a consistent strategy over time to gauge its effectiveness. It is counterproductive to chop and change specific trend plotting techniques when strategy testing, because this prevents the trader from understanding which specific factors are most influential on their performance.
Helpful tip: Experiment plotting trend lines using MetaTrader with a BDSTrading demo account. Pick out a method of drawing trendlines that suits your broader trading strategy and maintain your approach to avoid second-guessing yourself. In a demo environment, traders can hone their technical analysis skills without fearing costly mistakes.