Trend lines form one of the basic blocks of technical analysis and thus are very important to a chartist. Simply put, trend lines are nothing but sloping support and resistance levels and in fact price behaves similarly as it does when approaching a traditional (horizontal) resistance or a support level. Despite its simplicity, trend lines can often turn out to be subjective and thus can confuse a chartist if indeed they have plotted a trend line correctly. The most important aspect of trend lines is that they tend to work on any time frame and in any market which is why they are one of the most popular technical analysis tools for a chartist. It is possible to trade only with trend lines although they are mostly used in conjunction with other methods. A good example of trading based off trend lines is the speed resistance lines method.
How to plot trend lines correctly
Most of the information available in book and other websites note that trend lines can be constructed by connecting either highs, where they form a downward sloping trendline and thus tend to act as resistance or they can be constructed by connecting the lows, where they slope upwards and thus form a support level.
While trend lines are similar to the horizontal support and resistance levels, the biggest difference is that trend lines tend to project future support and resistance levels when projected as a ray.
Trend lines can be drawn by simply connecting highs or lows. However, we find trend lines to offer more validity when using a line chart and connecting the closing prices. The difference between using a candlestick or bar chart versus using a line chart is that the trend lines follow the closing price in a line chart. Therefore, during a downtrend, the closing prices are lower and thus the trendline drawn slopes lower and vice-versa in an uptrend.
The picture below shows a comparison of trend lines plotted using a bar chart and a line chart. You can notice that for the most part, there is not much of a difference between the two. However, on closer inspection notice where the trendline for the line chart started. Also as you scan your eye from left to right, you will notice how price starts to react in a more disciplined fashion, bouncing off from the downward sloping trendline for the third time, breaking the trendline to make a short test and then revisiting the trendline from above for a second time before pushing higher.
In comparison, the trend line drawn from the line chart doesn’t really offer much clues as we see how price managed to break the trend line from above and thus give a completely wrong information to the chartist.
So, to answer the question on which is the best way to draw a trendline correctly, we summarize as follows:
Switch to a line chart and connect the two or more significant peaks (in an downtrend) or troughs (in a uptrend). Once the trend line is aligned correctly, switch back to a candlestick or bar chart for further analysis.
The chart below shows the trend line which was plotted using a line chart and then switched to a bar chart, which gives a better picture into the unfolding price action.
Trend lines – Some important tips
In the following section we give some general tips to bear in mind when plotting trend lines.
Old Trend Lines: Trend lines work on the same principles of support and resistance lines. Meaning that old support trendline can turn into a resistance trendline when broken from below and vice-versa. In some cases, old trend lines tend to be respected by price action, but not all the time. Just because a trendline is broken doesn’t mean that it loses its relevancy. The chart below illustrates this point.
Notice how price broke this trendline but soon managed to break above it as well. A good distance later, price revisited this trendline to find support.
Slope of the trend line: Trend lines usually slope at an angle of 45 degrees; but that is not to say that steeper or almost flat trend lines are invalid. They are valid, but price tends to break away from such trend lines (steep or flat) quite easily. The interesting point is that despite the ease with which price breaks from a steep or a flat trendline, it becomes difficult for price to break back into the trendline on the reverse.
The chart above shows how a steep trendline was broken and an attempt to break back into the trendline failed. While price continued to make higher highs, it just was not able to break above the original trendline. The shaded area depicts how price started deviating away from the trendline as it made higher highs.
Using too many trend lines: Quite often we come across charts posted by traders which are scattered by tons and tons of trend line. Such an approach not only confuses the trader but also clutters the screen making it quite hard to ascertain the unfolding price action. The question that comes to one’s mind is how to keep trend lines to a minimum? The answer is quite simple. Only use the relevant price points such as the significant peaks and troughs in the chart. Although while drawing the trend line it might seem irrelevant as price breaks the TL’s quite often, given the fact that the trend lines are plotted at key price levels makes it all the more important.
To conclude this article, trend lines make for an important technical analysis tool that has the capability to predict future support/resistance levels when plotted correctly on the chart. While we don’t recommend using just trend lines as a trading method, when used alongside moving averages or candlestick reversal patterns with confirmation from oscillators can give more weight to your trading decisions.