When engaging in financial markets, it is pertinent to use every tool at one’s disposal. Trend lines play a crucial part in this equation, as they can help identify specific data points. It is a common practice to draw trend lines when performing technical analysis.
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Why People Use Trend Lines
Traders far and wide consider the trendline to be an integral tool for technical analysis. It doesn’t require much external knowledge to analyze a market either, as the price chart will be more than sufficient. Knowing the current market direction and capitalizing on the momentum is paramount.
As a trend line can connect data points on a price chart, it is often used to identify support and resistance levels. Every asset has “barriers” to overcome during a bull market and “potential bottoms” during a bear market. The difference between the actual data point and what you want it to be can be rather steep. As such, using trend lines to identify these points of interest is paramount.
Trend lines can have a slope, which is either positive or negative. A positive slope emerges during a bull market or after a trend reversal. Negative slopes are found in bear markets and can extend very deep.
The inclination of one’s trend lines can also help determine how strong the current trend is. A steeper inclination indicates a stronger bull or bear market.
The Ascending Trend Line
Traders will often try to spot ascending trend lines for their preferred market. An ascending trend line confirms a bull trend or market reversal after a bearish spell.
To draw ascending trend lines, traders need to identify a low spot on the chart and see if they can connect it to higher data points on the same chart. The connection between these points will indicate if the trend is real and where it may end. Depending on one’s chart timeframe, the trend line may look very different from what is expected initially.
The Descending Trend Line
A descending trend line works very similarly, yet it connects data points higher on the chart with those on lower levels. You can use this method to determine how steep the downtrend may become and whether there is any chance of a reversal in sight.
It is advisable to use a candlestick chart when trying to draw trend lines. Candlesticks – and the Heiken-Ashi format – make it much easier to spot potential data points.
A Trendline Is Not A Channel
One common mistake neophyte traders will make is assuming how a trendline and a price channel are one and the same. That is not the case, unless multiple trendlines are visible on the same chart. Traders will often put two or more trend lines on a price chart to determine whether a price will go above or below certain price points.
One has to understand that a price channel is only a visual representation of a market’s support and resistance levels based on the current time frame. It can be useful to analyze certain aspects, but is not necessarily required to make the most of market opportunities.
Limitations Of Trend Lines
If there is any aspect to take away from technical indicators and charting tools, it is how no solution is perfect on its own. A trendline has its own list of shortcomings, especially when more data sources provide information that may prove valuable to you. Additionally, markets evolve constantly, and a trendline may need to be redrawn regularly to maintain proper oversight of what is going on.
Price action of a financial market will deviate from your trendline sooner or later. When that happens, it is crucial to look at the necessary price points and make adjustments accordingly. Sticking to your preferred method – using lower lows or lowest closing prices, for example – is crucial. There is no need for any trader to adjust their charting preferences if a trendline is broken.
Using Trend Lines Properly
With the above information in mind, it is crucial to use the trend line formats to one’s advantage. As a trend line provides information on prior, current, and potentially future price points that are of interest, it is possible to adjust one’s trading strategy accordingly.
The first thing to keep in mind is how traders will always put trend lines under pressure. Markets will try to hover near a trend line regularly. As long as the value doesn’t break the trendline to the downside of the upside, the line in question remains valid. Otherwise, it is best to abandon it altogether.
Second, looking at a trend line provides information regarding the overall buying and selling pressure for that specific market. Knowing whether demand is higher than supply or vice versa can make a world of difference.
Third, it is essential to look at the trend line and the overall trading volume for that market. A rise in volume is often mandatory if a significant price swing is taking place. Otherwise, the market may give off a false signal, which has to be avoided.
Drawing Your First Trend Lines
Having the technical information down is only the first step. Traders need to learn to draw a trend line themselves. The best way to do so is by trial and error, combined with paper trading. It is often best not to risk one’s finances when experimenting with trend lines for the first time.
Something to look out for is if the price can hit your trend lines three times or more without breaking through it. From that point on, one can consider the trend line as an accurate analysis. It is always best to avoid coincidence when trading financial markets.
Using The Right Scale
A crucial tip both neophyte and advanced traders need to keep in mind is how the chart’s scale plays a crucial role. Without the right settings, it’s nearly impossible to find the correct data points. More specifically, different markets require different time frames, whether it be hourly, four-hour, daily, or weekly candlestick patterns.
For traders, the most commonly-used options are the arithmetic and semi-logarithmic scales. Either scale has its benefits and drawbacks. Finding whichever option you are most comfortable with can take a while, so feel free to experiment.
Finding Support and Resistance Levels
The main reason traders rely on trend lines is to figure out where a market may bottom out or hit a top. It may seem easy to chart these data points, but that isn’t necessarily the case.
An ascending trend line will often show support levels that will – in theory – provide a safety net of sorts. With a descending trend line, traders often identify potential points of resistance to halt further price progression.
A market can break both of these lines in quick succession. Particularly with volatile markets such as Bitcoin, trend lines provide some insight but are not the go-to way to analyze markets. A trend line is a tool in the belt, but not the cookie-cutter solution.
No one can deny the potential of trend lines when performing technical analysis on a price chart. Despite the usefulness of this tool, it is not necessarily foolproof either. It all comes down to how you set up things and draw conclusions from your lines.
There is no right or wrong method to experiment with a trend line. As long as one sticks to the basic principles of ensuring the line gets validated multiple times without breaking, it can still prove useful in the long run.
In the end, traders need to draw trend lines and other tools and indicators to perform technical analysis. There is no one-trick pony when it comes to analyzing financial markets.