3.15 What are trend lines and why are they important?

Technical analysis involves identifying chart patterns and trends in asset price movements. Trend lines are another important tool used by technical analysts. Lines on charts help identify the current direction of market prices, and thus help you make better trading decisions.

Experienced technical analysts believe that the trend is your friend, because identifying trends is the first step to good trading. There are three main types of trends that will help you determine the direction in which the market is moving. In this lesson, we will help you understand trend lines that will help you make good trading decisions that will result in profits.

In this lesson, we will focus on trend lines and explain the three types of trends in detail.

Content

• What is a trend line?

• What is a trend line useful for?

• Types of trend lines

• Trading signals based on trend lines

What is a trend line?

A trend line is an easily identifiable line on charts, connecting a series of price points within a specific time frame. The resulting line gives an idea of the direction in which the value of an asset may be heading in the near future.

As defined: a trend line determines the direction of movement of the price of a financial instrument. More specifically, a trend line allows you to see the trend and determine its price channel.

Drawing a trend line helps you understand what kind of trend - upward, downward or horizontal - we are dealing with on a given instrument in a certain time frame. In the following paragraphs you will learn how to draw a trend line.

What a trend line is useful for

Being able to draw a trend line is extremely important for any investor, whether trading on the stock market (such as securities and futures) or investing in the cryptocurrency market. Observing the trend is crucial for making decisions to buy or sell assets. Knowledge of the formation and fluctuation of trends also becomes essential for assessing the timing of entering and exiting trades.

Statistics reflect the regularity of investing according to the trend, that is, entering long (buy) positions in an uptrend or short (sell) positions in a downtrend. A trader increases the likelihood of closing a position profitably by trading in the direction of the main trend rather than against it.

Types of trend lines

As mentioned earlier, there are three main types of trendlines: 

• Downward trend

• Upward trend

• Horizontal trend

Drawing trend lines in the three different scenarios: 

Drawing trend lines in a downtrend

The first trend we will discuss is a downtrend, also known as a bear  market trend. In this trend, the level of the asset price gets lower and lower. Outlining the trend line will help you better spot the downward trend. In the case of downtrends (supply dominance), it is necessary to highlight the price maxima for the analyzed time frame.

If the subsequent price peaks are lower than the previous ones, the downward trend has probably been successfully confirmed. A downtrend line is a line that crosses price peaks that continue to fall.

To understand a downtrend line, let's look at the chart below.

 

A way of determining a trend line in an uptrend

Uptrends or bullish trends are identified in a similar way. The uptrend line must follow the price lows. If the trend is actually an upward trend, then each subsequent price minimum (the so-called low) will be higher and higher. The longer the period of such a trend, the stronger and more reliable the trend.

For example, a sudden change in a trend lasting several weeks or several months is much more likely than a change in a smaller, weekly trend, which in the context of the main trend is only the so-called micro trend. Let’s have a look at the chart below to understand an uptrend line.


 

Determining the trend line in a horizontal trend

Investors have a harder time when faced with a horizontal or lateral trend. A horizontal trend means the stagnation and equalization of the forces of demand (bull market) and supply (bear market).

A horizontal trend line, as the name implies, is relatively horizontal, even and constant. There are also other smaller upward and downward trends, but in general, in a horizontal trend line, successive price minima and maxima remain relatively at the same level. This is best illustrated by the chart below.

Trading signals based on trend lines

Drawing a trend line allows you to spot price signals. If, in a bullish trend, the next price maximum breaks through the trend line drawn by the levels of the previous price maximums, which regularly fall lower and lower, such a situation should be considered a buy signal. These signals mean that a trend reversal is likely to start appearing on the chart.

Similarly, a sell signal for an uptrend will occur when the next minimum of the price crosses the lower line of the uptrend, based on previous and higher lows. Although building any investment strategy practically cannot exist without being able to see the above situations, in order to increase the chances of making profits you should also consider fundamental analysis along with all the tools of technical analysis.

In the next lesson we will look at the concept of moving average.