3.07 What are trend lines and why are they important?
This lesson focuses on trend lines and explains three types of trends in detail.
Technical analysis is all about identifying chart patterns and trends in the price movement of an asset. Trend lines are another important tool used by technical analysts. The lines drawn on the charts help you determine the current direction in market prices which in turn assist you with making better trading decisions.
Experienced technical analysts believe that trend is your friend because identifying trends is the first step in making a good trade. There are three main types of trends that will help you determine the market direction. Let us help you understand trend lines to make good trades that end up delivering good profits.
This lesson focuses on trend lines and explains three types of trends in detail.
- 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 recognizable line that is drawn on charts by connecting a series of price points in a specific time interval. The resulting line will give a good idea of the direction in which the asset’s value might move in the near future.
According to the definition, the trend line sets the direction of the price movement of a given financial instrument. More precisely, a trend line allows you to see a trend and determine its price channel.
Drawing a trend line helps to understand what type of trend - an upward, downward, or horizontal - you are dealing with on a given instrument and in a specific time interval. Let's see how to draw a trend line in the coming sections.
What is a trend line useful for?
The ability to set a trend line is extremely important for any investor, regardless of whether they are trading on the stock market (e.g. securities and futures) or investing in the cryptocurrency market. Seeing the trend is crucial for making decisions about buying or selling an asset. The knowledge of the formation and fluctuation of trends also becomes indispensable for the assessment of the moments to enter and exit a transaction.
The statistics show the regularity of investing in line with the trend, i.e. entering long (bid, buy) positions in an uptrend or short (offer, sell) positions in a downtrend. A trader increases the probability of closing the position with profit, as opposed to opening the position against the main trend.
Types of trend lines
As we mentioned before, there are three major types of trends that are given below.
- Horizontal trend
Let's look at how to draw trend lines in the three scenarios.
A way of determining a trend line in a downtrend
The first trend we are going to discuss is the downtrend, also known as bearish trend. In this, the price level of an asset becomes lower and lower. Drawing a trendline will help you see the downtrend clearly. In the case of bearish trends (dominance of supply), the price maximums for the analyzed time range should be distinguished.
If the next price peaks (the so-called highs or peaks) are lower than the previous ones, then probably the downward trend was effectively confirmed. A downtrend line is a line that crosses price peaks that keep getting lower.
Let’s look at the chart given below to understand the downtrend line.
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.
A way of determining a trend line in a horizontal trend
A growing number of problems for investors and traders come with a horizontal trend. A horizontal trend means stagnation and alignment of the forces of demand (bull market) and the forces of supply (bear market).
A horizontal trendline, as its name suggests, is relatively horizontal, even, and constant. There are also smaller upward and downward trends, but overall in the horizontal trend line subsequent price lows and maximums remain relatively at the same level. You will understand it better by looking at the chart below.
Trading signals based on trend lines
Drawing a trend line allows you to spot price signals. In a bear trend, if the next price maximum breaks the trend line marked by the levels of the previous, regularly lower, and lower price maximums, then such a situation should be treated as a buy signal. These signals mean that a trend reversal is likely starting to appear on the chart.
Similarly, a sell signal for an uptrend will occur when the next price minimum crosses the bottom line of the uptrend, based on the earlier and higher lows. Although building any de facto investment strategy cannot exist without the ability to see the above situations, you should also consider fundamental analysis along with the technical analysis tools to increase the chances of making profits.
We will discuss the concept of moving averages in the next lesson.
This material does not constitute investment advice, nor is it an offer or solicitation to purchase any cryptocurrency assets.
This material is for general informational and educational purposes only and, to that extent, makes no warranty as to, nor should it be construed as such, regarding the reliability, accuracy, completeness or correctness of the materials or opinions contained herein.
Certain statements in this educational material may relate to future expectations that are based on our current views and assumptions and involve uncertainties that could cause actual results, performance or events to differ from those statements.
BB Trade Estonia OU and its representatives and those working directly or indirectly with BB Trade Estonia OU do not accept any liability arising from this article.
Please note that investing in cryptocurrency assets carries risks in addition to the opportunities described above.
3.03 The Dow theory: principles and statements
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3.05 Candlestick charts and patterns
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3.02 Understanding technical analysis
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