Trend Lines - Overview
Trend Lines are one of the oldest technical indicators. Trend lines are used to identify and confirm existing price trends. They can be drawn on any timeframe and can be used on any price chart. The key to using trend lines effectively is the methodology used to draw them on the price chart. Simply put, a trend line is a straight line that connects two or more swing points. A positive sloping line is defined as an uptrend. A negative sloping line is defined as a downtrend.
Positive Trend Line
A positive uptrend is when there are higher highs and higher lows on the price chart. If the price is contained by this upward sloping line, the trend is assumed to be intact. This means that there is more demand than supply as the price heads higher. Many new traders make the mistake of assuming that a break of a trend line is going to lead to a steep sell off. While this is potentially true, traders will have to assess the volume and price action on the break of the trend line. Often times the price will have a false break of the trend line only to continue higher. One method for trading positive trendlines is to buy each successful test of the trend line at support.
Downtrend Line
A negative downtrend is when there are lower highs and lower lows on the price chart. If the price is contained by this downward sloping line, the trend is assumed to be intact. This means that there is more supply than demand as the price heads lower. Traders should look to short each failed test of the downtrend line.
Slope of Trend Line
The slope of the trend line is a key component of analyzing the strength of the primary trend. Newbie traders will often look at a steep incline and use the first break of the line to sell short the security. The steeper the slope of the line, the less reliable is the signal generated from the break of that line. When going counter to the primary trend, you will want to wait for both the trend line and the previous swing point to be broken. Remember, that a trend line break does not equal a new trend, it could just mean the slope of the trend is slowing up.
Drawing a Proper Trend Line
A valid trend line is comprised of two or more points on a price chart connected by a straight line. The origination point of the trend line is not necessarily the high or low point of the price move. A proper trend line starts from when the actual move begins. The two points on the trend line should be between two pivots. These swing points should have enough price movement to construct a trend line capable of containing the trend. The last component of a trend line is the third point, which is contained by the trend line constructed by the first two points. Trend lines are like every other indicator in that it may not work as intended for every security. So, if you find that the price continually breaks the trend line, do not force it on the chart. Use some other indicator to gauge the direction and trend of the security.
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