Price Action: Trend Lines

Trend lines, drawing and trading based on trend lines - that it what today’s article from the series on Price Action materials is dedicated to, that is trade without indicators. This post is aimed primarily at beginners, but, perhaps, old bristly forex traders will find for themselves something useful 🙂

Trend lines are widely used by traders to find entry and exit points, as they can serve as an indicator of the trend change. If the trend line is drawn correctly, it will be a very accurate instrument, indicating the future direction of the price movement. However, a large number of traders, especially beginners, make elementary mistakes and build the trend line in a wrong way.

How do we draw them?

The trend line must connect as many bottoms as possible (at least two) - this is the rising market. And for the falling market, respectively, we will connect the tops. It is easier to show in practice how it is done. In MetaTrader, there is an appropriate tool for drawing trend lines. On the picture, the “Trendline” location on the toolbar is indicated by the mouse pointer. We push this button. And the mouse cursor slightly changes.

We see some kind of cross, and under it, a little bit to the right is a line image.

To draw a trend line, first we need a bottom for the rising market, and then we connect the next local minima.

On the chart, we see a really clear and explicit textbook example. We move the mouse across to the first bottom and draw the line from it so that it connects as many points as possible - the following bottoms. Which means points, where the candles were trying to go down. But this has not happened, and the upward movement continued. We obtain such a line here (see the chart above). It doesn’t have to perfectly connect our points. Somewhere some candles’ tails can stick out. This is normal because we are more interested in the question of predictions accuracy for future trend movements, rather than the beauty of the lines. The trend line shows us a kind of level, a floor, from which the price bounces periodically and continues the upward trend. As we can see further, uptrend is intensifying. Price moved greatly from our line, but, nevertheless, continued to swirl around it for some time. Over time, we see that the trend lines are obsolete, and we need to draw new ones.

Let’s now try to draw a trend line for a bear market. In the growing market we were connecting the bottoms, but here we will connect local maxima, which are gradually lowering, thus creating a down market. Move the mouse over our first local maximum in order to draw a trend line, and connect the next local maxima that appeared on the chart.

Thus, we’ve got a trend line for the bear market and drew it. As you can see, after some time there is a situation in which the trend line will be not as important as it was original. Just as in the first case, this market became much stronger, and for some time the return to the trend line does not occur. And then … the trend line becomes simply outdated. But nevertheless, when the market went up, we could draw another trend line exactly the same way as the first, but in a different place. Let’s demonstrate this. We have new higher bottoms, which gave us an opportunity to draw another line for a shorter period.

It would look approximately like this (see the chart above). Such a picture on a chart is called: “A secondary trend line.” So, we first drew our main line, and then the market had switched to a more rapid growth, and we were able to draw a secondary trend line, which was actual not very long. But, nevertheless, if it continues to move up, our secondary trend line would play an important role. Do not try to do everything according to some instructions, according to some piece of paper. Nobody has canceled a common sense here. When drawing the trend lines, you should take into account how the market reacts. So, we try to find those places where it bounced, trying to find some platform, a certain line, floor, as I said, from which the market rebounds. It is also worth mentioning that the trend lines may be different. It all depends on what time period we are interested in, ie. how long we will keep the position expressed in a number of candles. Because at absolutely any timeframe the rules of lines constructing remain the same. Which means that we can look for some small trends, or we can look for some significant ones, which have a greater length.

For example, here (see the chart above) we had a very small short-term bearish trend. And we could draw a trend line if traded on this interval. Let’s draw a trend line. For example, here we can draw a small trendline down, but we still have a long-term uptrend that we could draw this line.

The upward trend, as we can see, lasted a lot longer than our little downward trend, and comparing to our longer uptrend, is just a correction and return to a longer trend line, and nothing more. Again, it all depends on the period in which we trade. If you trade for some ten candles, then at the moment the downward trend would be more important. And if you are using a longer time period in your trade, then, respectively, you’d pay more attention to long-term trends.

How to use trend lines in trading?

Let’s say you’ve drawn a trend line. What to do with it next? Firstly, the trend line acts as a good support zone, i.e. level from which the price will theoretically theory and most likely bounce in the presence of a stable trend. If the line crosses this support zone you can already trade it. Let’s look at the rebound from the line, ie. a situation in which the price returns to the trendline, and then again bounces from it – it can be regarded as a signal for the trend to continue and to open an appropriate position. For example, on the same chart, the price went down and then went back to the trend line. The basic chart wouldn’t be drawn yet, and we would draw the line a little lower, and then we would correct it.

We see a pin bar that could be interpreted as a bounce from the trend line, and then we open a sell position.

And here we see (see the picture above) that the price goes back to the trend line. It is an obvious bounce, as the candle is directed towards our bearish trend. And here again, we would have a possibility to sell, if the price went up to the trend line, but the candle is opposite to our trend. For example, the trend in our example goes down, and the candle is bullish, and it came close to the trend line. Provided that our candle had just closed, should we sell now? No. It is necessary to wait for the confirmation signal when the candle is drawn in the direction of our trend. In this case, we see a bearish candle. In the hope that the trend continues, we can sell.

“Break” Tactics

In addition, there is a strategy of trading on trend lines called „break”, when the price breaks the trend line in the opposite direction of our trend. And, accordingly, there is a reversal. Let’s show it on an example. We had a breakdown of the trend line. In the beginning, we draw our line. The chart shows clearly where was our trend line, and in addition to the actual breakdown, false ones are also visible.

There has been a breakdown. But it’s not worth entering the market by the candle that had just broken through the trend line. It is necessary to wait for another candle to confirm that the signal is correct, and it is not a false breakdown. In the chart, we see a trendline breakdown by a candle. We are waiting for another candle. There was a bullish candle, but we still do not sell and are waiting for what will happen next. And we see that the price has returned to a value above the trend line, and the upward trend continued. In this case, it can be regarded as a rebound from the trend line. And somewhere after this candle (see the chart above), after confirmation of the trend, we can buy. Again, they are just rebounds.

We had a breakdown (see the chart above). The price has broken the trend line. But we are waiting for another candle to confirm it. And it is again bearish, which indicates a reversal. And in this case, we might sell, as there is confidence that all take-profits would have been taken due to a reversal. Important: after the trend line breakdown there are two possible scenarios: either a reversal or consolidation before the market continuation, as happened in our case.

Now we see a trend line on our chart. We see an upward trend and its breakdown. There is a bearish candle that has broken through the trend line, then a bullish candle appeared. We wait what will happen. Then we see another bear candle with a tail up, which should serve as a sell signal to us. Of course, it all depends on your intended goals and your projections for the duration of the downward trend movement. Again, we should pay attention to other technical indicators, chart patterns, areas of support/resistance, etc.

In this case, we have the chart there was some consolidation, some correction, which resulted in a chaotic, almost horizontal set of candles, which is then returned to a bullish trend. And the bull trend continued. That is, we are seeing consolidation before resuming the trend, rather than a reversal after the break.

It is a trend line break a market reversal or consolidation signal?

Actually, predefine it is very difficult or rather impossible. But we can make some judgments on the basis of the angle of the trend line. The steeper the angle of the trend line inclination, the greater the likelihood that after the breakdown a consolidation rather than reversal will follow. Accordingly, the steeper the trend, the greater the likelihood that it will break at some period of time, and then continue.

But if the line is smoother, has a greater length, for example, as on the chart above (we see that the downtrend lasted quite a large number of candles), after its breakdown, we have a reason to believe that this is a signal for a reversal that actually happened in this case. But, unfortunately, it is not always so simple. In addition to the trend lines, other signals should be taken into account. Once the trend line was broken, it does not mean that it should be removed from the chart, because it can still render us a service. As you probably noticed, the trend lines that we draw, automatically continue in the future, helping us to set goals and stops on their basis, as well as finding potential future areas of support and resistance. Let’s look at an example when seemingly irrelevant trendline shouldn’t be removed from the chart.

What do we see in this case? The chart shows a definite trend line. Next, we see its breakdown, and that after the breakdown the price returned back to the trend line to test it. The trend line we had was bullish. It was a support from which the price bounced several times. Once the price has broken through it, the trend line for a short time becomes a resistance. Price, as a rule, tends to return to it and then continue its movement in the opposite direction. In this case, the price broke our bullish trend line, and then it came back and almost touched her tails, thereby testing the trend, as a resistance. After that, there was a slight zig-zag motion, after which the price decided to go down.

Important: once the trend line was broken, do not rush to remove it. Perhaps the price will return to it, and you will thus determine that it is a reversal pattern. Of course, provided that the price trend bounces from the trend line, and it does not break it and the past trend continues. Naturally, the greater the length, the greater the number of lows or highs the trendline connects, the more important is this trend line. Also important is the number of touches: number of times the price bounced from the line, and the angle of the line. The more gently increasing trend line we see, the more important it is for us. The steeper the angle of a trend line, the greater the likelihood that it will be broken, so it is less reliable. The trend line can also be used as a moving support zone.

For example, somewhere here you made a buy order. Then gradually shift your stop loss just below the trend line, and with each candle move it. It turns out a kind of analog to a trailing stop. Trailing stop - an order to close a position, which is automatically changed by the trading terminal, in accordance with the specified trade settings. It allows you to automate the process of trading in terms of closing the position.

And finally…

And finally, let’s look at how to determine what minimum distance will the price pass after the trend line breakthrough, because if it will be a reversal, the price, of course, can be the same for a very long time. We also need to have some minimal initial goals, which will work with a high probability. In the chart, we can see the trend line and the price continuing to rebound from that line. Then we see the occurred breakdown, we have its confirmation, so we open the position.

Open a position somewhere at this point (see the chart above). Now we need to set a goal? Decide what take profit to set. This can be done with our previous trend line. Look, what is the maximum vertical distance from the trend line to the base or to the maximum in the case of the bullish trend line. The price passed from the trend line. And this distance in points will be our first potential target.

In this case, the maximum distance was 410 points.

At this stage, we bought. We put off our 410 points, which were taken after a short growth and correction.

For this trendline, we measure the maximum vertical distance (from high to the trend line). The distance is equal to 260 points, and we put it off, we immediately after the line breakthrough.

What do we see? When moving down there was a maximum of 300 points. That is, our goal has quite worked.

The graph above the maximum vertical distance from the highest point to the trend line was 370 points. We sell after the break, so put off the 370 points as the target.

Here we see that they worked well.

Here in this way, you can identify potential points of profit-taking at the opening position after the trend lines breakdown. This method is used by the trendlines themselves.

Take care, Michael

ForexTraderPortal.com