The Trend line is among the most important tools used by technical analysts. Rather than looking at the past business performance or other fundamentals like market news, technical analysis analysts look for trends in price action by drawing trend lines on a price chart.
And what better tool to look for trends than trading trendlines, right?
Why is it important to identify trends, I hear you scream?
Well, technical analysts believe that identifying the trend is the first step in the process of better understanding market sentiment and making a good trade. But more on that later.
First things first.
A trend line is a straight line that connects at least two points and extends into the future to act as a line of support or resistance. Trend lines connect significant lows in an upward trend and they connect significant highs in a downward trend, creating dynamic resistance.
On that matter, dynamic resistance means that as time changes, so do the price of the support or resistance. For example, in an uptrend, the level of support goes up as time progresses. In a downtrend, the level of resistance goes down as time progresses.
An uptrend line has a positive slope and is formed by connecting two or more low points. The second low must be higher than the first for the line to have a positive slope. These bullish trendlines signal that market prices of an asset in the financial markets are rising and are expected to continue rising as long as the trend is valid.
A downtrend line has a negative slope and is formed by connecting two or more high points of a currency pair. The second high must be lower than the first for the line to have a negative slope. Unlike uptrends, these bearish trendlines indicate that prices of a financial instrument are falling and will continue to fall as long as the trend line continues.
IMPORTANT TIP: When you draw trendlines, at least three points must be connected before the single line is considered to be a valid trend line. If the trade price breaks below or above the trend line, then the trader can identify trend reversal and the direction of the trend.
Let’s see what Uptrend and Downtrend trend lines look like on an actual Forex chart.
To draw trend lines properly in the forex market, all you have to do is locate two major tops or bottoms in a security’s price and connect them. What’s next?
Nothing. Really, it’s that simple.
Want to see another example of what downtrend and uptrend look like on a Forex trading chart?
There ya go
Notice that when drawing trendlines in a downtrend, you draw them above the price on the swing highs at swing lows. On the other hand, when you draw trend lines in an upper trendline, you draw them below the price.
Yup, that’s right. There is a third type of trendline trading system on top of downtrend and uptrend. This is known as sideways and is a trend analysis method in which a trader is neutral about the direction and usually is looking for market consolidation in currency trading. Not sure you understand? Let’s see examples.
A sideways trend is the horizontal price movement that occurs when the forces of supply and demand are nearly equal. Or, in other words, the asset is in equilibrium, which means many traders are looking for a support and resistance level and trade between these parallel trendlines. This trendline strategy is also known as range trading.
In a sideways trend, the price moves in a narrow band, neither going upward or downward.
Since there is no clear directional trend, sideways trends can be very frustrating for short-term traders and trend traders. At the same time, if used correctly it is one of the most boring but rewarding trendline analysis methods for forex traders.
As a general rule, according to this trading strategy, experienced traders sell the asset when the price approaches resistance lines and buy the asset when it touches the horizontal support line. In case the trendline breakouts above or below on any time frame on a chart, then there’s a new trend reversal and the stop loss order will be set at one of the sideways lines. Nonetheless, you need to take into account that when trade trendline breakouts, there’s a significant risk as there are lots of false breakouts. To solve this problem, many traders wait for the first candlestick to end and then enter a trade.
Trend lines are great technical analysis indicators that help you find an entry and exit point when you analyze financial instruments. There are three types of trend lines in trading the forex markets:
In case you ever get confused, we have prepared a little cheat pic for you.
Feel free to download it by clicking below.
REMEMBER: It takes at least two tops or bottoms to draw a valid trend line but it takes THREE moving upwards or downwards price movements points to confirm a trend line.
And most importantly, DO NOT EVER draw trend lines by forcing them to fit the forex market.
If it doesn’t fit, you must acquit.