Trendline Analysis 

Last Updated September 7th 2021
7 Min Read

People often start trading thinking that they can earn profits right away. Almost all new traders are motivated by this new enthusiasm to try and earn a quick profit. But, mere enthusiasm and ambition cannot take you far. You have to combine it with a thorough understanding of how things work and make your decisions accordingly. One of the first steps towards achieving trading success is the ability to identify trends and analyse trendlines.

What is a ‘Trend’ in a Trading Context?

Several definitions are attributed to the word trend. A trend refers to the general direction that something moves. It can be up or down. In the case of trade, it refers to the movement of the price of an asset in a particular direction. The asset could be anything – stock, commodity, index, currency, and so on. Trends identify with all assets across the market.

If you can identify the trend, you will have an advantage over amateur traders and will enjoy greater success in trading. However, identifying a trend is not always very easy as a trend can vary in length. So, you can have short-term, medium-term, and long-term trends. Once you mark a trend, you’ll get a better idea of the direction the market is headed and use the information to your advantage. Trading trend indicators will help you decide if you should trade with or against the trend.

Regardless of the decisions you take, the key to success is the discipline to wait for the right timing and not jump the gun. Impatience might lead you to a bad trade when a good trade is just around the corner.

Check Out: Top Chart Patterns Every Trader Should Understand

How to Identify Trends in Trading?

Identifying a trend is not too difficult. Here are some of the rules you can follow to recognise trading trend reversals and trend indicators.

4 tips to recognise a trading trend:

1. Follow the series of highs and lows

If you are looking at a chart with no indicators, it is easy to spot the direction of the trend. If the charts show an upward trend, the upper end of each subsequent candle is higher. Likewise, the lower end of each subsequent candle will be higher than the previous candle. If a chart reveals a downward trend, the upper and lower end of the candle will go lower and lower with every subsequent candle.

In the case of a horizontal trend, the upper ends of each subsequent candle will remain around the same price. This is true for the lower ends of each subsequent candle as well. To confirm a trend, there must at least be four pivot points, two each for the upper and lower ends.

2. Mark the trend line

In the case of a linear line, you must have at least two points of contact. It means that the trend line must cross at least two candles at their lowest or higher points. However, to confirm, you need to ensure that there are at least three points of contact. Generally, the more points of contact available on the trend line the stronger your trend line will be.

3. Identify the trend

Although there are horizontal trends too, almost all your trends will either be an upward trend or a downward trend. Recognising a trend is the key to successful trading with strategies that will help you earn high returns. If there is an upward trend, the trendline will be marked below the chart (candles or linear). This kind of trendline is referred to as a support line because it supports the upward trend. Generally, when an upward trend hits the support line, it is likely to bounce back up as it is supported by the trend line. But when the trend breaks below the line, it is a signal for traders to purchase a PUT option.

Conversely, if you spot a downward trend, the trendline will be marked above the chart. This kind of trendline is referred to as a resistance line because it resists the price from going above the trendline. Normally, if an asset on a downward trend reaches the resistance line, it will be pushed further back down. When the asset price breaks above the resistance line, it is an indication for trades to purchase a CALL option.

4. Choose the right moment to trade

Although marking the trend can help, it is merely the first step, and you will not succeed with trend strategies if you aren’t disciplined enough to wait for the right setup. To get a better understanding of the market sentiment, it is always better to start with a zoomed-out picture of what is happening. For instance, look at a daily chart. If you cannot find an obvious trend on it, try looking at an hourly chart – say, a four-hour chart.

Whatever asset you are tracking, only once you’ve recognised a macro trend can you move on to trading within your favourite time frame. Some people prefer 15 minute and 5-minute time frames. After zooming out from a daily chart to a 15 or 5-minute chart, you should mark the trend again and wait for a breakout.

How is Trend Used?

Trendlines can be very useful as a break of the trendline usually signals a trend reversal. So, when an uptrend line is broken, the prior uptrend has ended. Conversely, when a downtrend is broken, it means that the prior downtrend has ended.

A popular strategy followed by the traders is waiting for the price to touch the trendline and trade it. During an uptrend, when the price breaks a higher low and reaches the lower trendline, traders will go for a buy. During a downtrend, as the price makes a lower high, traders will trade the trendline and start selling. A trader trading the range goes on to buy when the price touches support and sell when it touches resistance.

You can use the trendline to estimate the future price trajectory. It can also be used as a warning signal when the trend may be reversing. You should remember that trends occur on multiple timeframes. As such, even when the price may be showing an overall downtrend on the daily chart, it might be showing an uptrend on the 15-minute chart. You will gain better insight into the future price movement of the asset by looking at both longer-term and shorter-term trends.

Read Also: Analysis Paralysis: How To Beat It And Take Back Control

Drawing a Trendline

Most traders find it cumbersome to draw a trendline. It needs better knowledge and years of experience to get things right. However, if you are new to trading, you need not panic. Several websites and platforms help you to draw a trendline automatically with the help of AI. They not only draw the line for you but also colour them based on the strength of the trend to make things easier for you.

The Strength of a Trendline

One of the biggest challenges faced by a Technical Analyst is to decide which trend to use when equipped with two trends co-existing. To arrive at the correct decision, the analyst determines the strength of a trendline. This can be visually performed by an experienced Technical Analyst. However, for traders, using trendlines with coloured lines are great tools to make the right decision.

The strength of a trendline is primarily based on the following three factors:

  • Number of touches – the more the touches, the stronger the line
  • The angle of the trendline – flatter the trendline, the stronger it will be
  • Length of the trendline – the longer the trendline, the stronger it will be

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Duration of a Trendline

As mentioned elsewhere, a trend varies in length (duration). It means that the lines can reflect either short, intermediate, or long-term trends. As different traders understand the duration of trends differently, it can be hard to pinpoint them. You just have to remember that you can define a trend by its duration too and that the duration of trend used will depend on the type of trader you are. E.g., a short-term trend can be one to four weeks long whereas a long-term trend can be any period higher than six months.

Conclusion

It is important to identify and understand trends because they help you trade with them rather than against them. The general saying is “trend is your friend” because trading in the direction of the trend maximises your chance of success. It is possible to identify trends with the help of various technical analysis, which consist of both trendlines and technical indicators. However, as you can see from above, using a trendline is the strongest form of confirming a trend. Understanding the trend also helps you to avoid false buy/sell signals. This is crucial because some indicators such as oscillators behave better in sideways trends and others like trending indicators behave better in trending markets. Hence, using trendlines can lead to a much better success rate in identifying and trading a trend.

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