Trend lines are one of the most useful and versatile tools used by forex traders.
But when it comes to drawing the lines, many traders, especially new ones, encounter issues.
In today’s article, I’m going to show you how trend lines should be drawn.
I’m also going to detail a couple of different ways you can them in your trading, and give a quick overview of what they are, so if you’re a new trader who doesn’t know what a trend line is, this section will bring you up to speed.
A Quick Introduction To Trend Lines
If you’re not familiar with trend lines, here’s a quick overview of them.
So a trend line is a technical tool you can quickly and easily use to get information about the current trend.
The tool itself is very simple; it’s just a line you draw on the chart.
To use it, you find the beginning of a new trend (or what you think is a new trend) and then place the line on the first two swings the trend has made.
For up-trends you place it on the first two swing lows, and for downtrends you place it on the first two swing highs.
The location of the price in relation to the line, gives you information about the current trend.
Here’s a trend line drawn on a small Eur/Usd downtrend.
You can see this line connects 4 swing highs.
The first two highs are what give the trend lines it’s angle.
Once it’s placed on top the line projects where potential swing highs could form in the future.
So when the line has been placed, and the price is coming back to it, you know another swing high could form when it touches it, thus, you have an idea of when and where a reversal could take place.
Also, if the downtrend is going to continue the price should not break past the trend line. But as you can see, on the 26th it shoots upwards and breaches it, indicating the downtrend may now be over.
This is just two ways the trend can give you information about the current trend.
How To Draw Perfect Trend Lines Every Single Time
The biggest problem people have with trend lines is drawing them.
Most traders don’t draw trend lines the right way.
This causes them to be ineffective, because they end up giving the wrong information about the trend, which causes the trader to make bad trading decisions.
Trend lines need to be drawn correctly.
That means placing them on the right swings in the right place.
For up-trends, they need to be placed on the first two swing lows the up-trend made.
For downtrend, they need to be placed on the first two swing highs the downtrend made.
Here’s an example…..
As you can see, drawing a trend Line is a relatively straightforward process.
In the image above, you can see two swing highs. One high is lower than the other, thus indicating the price is in a downtrend.
After the swing high at point 2 has been created, and the price moves away convincingly with a similar amount of momentum as seen after point 1, you can draw a straight line that links the two isolated highs.
In this example, we were lucky and caught a retest straight after, giving us a confidence boost in the potential of our newly identified trend. We don’t know if, or when, the price will come back to retest the trend line again, so we extend the line well into the future.
As we monitor the price and see that it is coming back to touch the line for a 3rd time, we are looking to see if our existing trend line will hold to validate it, or if the price will plough straight through it to invalidate it.
This is why we need to see the 3rd touch, as without it we have no confirmed trend and the trend line is meaningless.
Ideally, we won’t have to tweak or move our trend line once the price comes back to it, but we may find that price does not react cleanly at the point of ‘contact’, and that a slight tweak gives the best fit through our 3 or more connected points.
Remember, drawing trend lines is purely subjective and rarely perfect, since the market does what it wants to do, not what you want it to do, therefore, some leeway, which comes with experience, can be given to create valid and meaningful Trend Lines.
The price may sometimes close just the wrong side of a trend line, only for the next candlestick to open and immediately close back on the trend side.
This is normal and usually happens when there are a lot of people watching the same level, either because they have the same trend line drawn, or it coincides with another point of confluence, such as a fibonacci level.
This can be seen at touch point 3 in the previous image (not marked on the drawing), where price comes back to the trend line and validates it by closing at it, and then reversing and falling away quickly, as shown by the large bearish candlestick (marked with an arrow).
The price does test the trend line again after the big bearish candle forms, but this time, it stops exactly at the trend line and falls away as the sellers resume control.
Always Draw Trend Lines From Highs And Lows, Not Candle Bodies
If you’re tempted to drawn trend lines from candle bodies instead of highs, don’t.
Many traders make this mistake, and then wonder why the trend line is giving them wrong information.
A perfect example of why trend lines shouldn’t be been drawn through candle bodies is shown below.
You can see the trend line has been redrawn across the same two points, but instead of drawing the line from the tip of the tails, like I did in the previous image, I’ve redrawn it across the candle bodies.
This may not seem like a big deal, but look what happens when the price comes back at point a).
It touches the trend line with a tails…twice, and then moves away in the direction of the trend….
Great, we now have trend line validation, but the body of the candlesticks did not touch the line this time…so does that count as a valid touch?
After the price moves away for a couple of candles, it heads back towards the trend line, crosses it and then closes the other side of it.
The next candle opens, takes out the high of the previous candle and closes, thereby now invalidating your trend line and by the line rules, the current downtrend is now over. The very next candle is the large reversal candlestick which brings the price back below the trend line.
An indecision candlestick forms and price again rallies, crosses and closes beyond your trend line and then hesitates before finally falling away with three large down candlesticks. Confusing or what?
Well, just imagine if you were trading at levels a) and b).
If you were holding a position at a) or had entered short after validation at a), you would be creating unnecessary indecision and taking unnecessary heat, wondering if you had just made another mistake as you watch the price eat well into your stop loss, having just crossed, closed and opened the wrong side of your now invalidated, newly validated trend line!
All of this unnecessary tension could have been avoided, by just lifting the trend line to the highs of the tails as in figure 3 and in figure 5 below.
When the trend line is redrawn across the highs a completely different story unfold at point a).
It’s not until the price actually closes at the trend line (just past it) and immediately reverses, that the trend line is validated.
The one touch and big reversal candle gives us confidence in the newly validated trend line, and even when price rallies and returns to it, this time, with the trend line drawn correctly, price stops right on it, reverses and immediately falls away with no real cause for concern.
It was just by chance the perfect opportunity existed for me to demonstrate not only the correct way to draw trend lines, but the reasons why we draw them that way.
It also demonstrates how, with amazing accuracy, price can respect trend lines and other levels of support and resistance, often to the pip….which when you consider that lines drawn on your screen are just that…lines…it pays to be as accurate as possible with all your analyses, no matter how simple your techniques may be.
What Does It Mean When A Trend line Breaks ?
First of all, it DOES NOT ALWAYS signal a reversal.
It merely indicates that the trend you were following is now over. From that point, price may move sideways, resume a similar trend at a later stage, or start to form a reversal pattern.
It is beyond the scope of this article to discuss in depth, the nature and behaviour of price in trends, so let’s concentrate on the essentials.
A trend line drawn on a downtrend is considered broken when the price crosses and closes ABOVE the trend line, so long as the next candle opens and fails to close back on the trend side of the trend line.
A trend line drawn on an uptrend is considered broken when the price crosses and closes BELOW the trend line, so long as the next candle opens and fails to close back on the trend side of the trend line.
Let’s take a look at some examples.
Here’s another one…..
In the image above, we have a well respected uptrend trend line.
It is interesting to note that the first candle which breaks this trend line closes the other side of the line, but the next candle immediately reverses and closes back on the trend side of the line.
The following candle re-breaks the trend line, closes the other side, and then the candle seen after fails to re-cross and close on the trend side of the Line – therefore signalling the current trend is over, and that the trend line is now considered broken.
Hopefully, it’s clear from the descriptions and images how a trend line break is defined.
Two Ways You Can Trade Trend Lines
Trend lines can be used in lots of different ways and in a variety of trading strategies.
I haven’t got time to list every single way they can be used here, but I have left a small overview of the two most popular ways traders use them below.
1. Trend Line Bounces
Trend lines, because they extend out in the future, gives us an idea of when and where new swing highs or lows are likely to form.
When the price returns to a trend line and moves away – creating a new swing in the process – it’s called a bounce.
Trend lines bounces can be great way for you to get into the current trend.
The way to trade them is simple….
You wait for the price to return to the trend line and then when it hits, you watch the price to see if a candlestick pattern forms.
If it does, you enter a trade with a stop loss above the high or low of the pattern.
And that’s it, then you just ride the trend.
2. Trend Line Breaks
Earlier, I said that a break of a trend line does not signal a reversal.
And it doesn’t, but reversals do often occur after a line breaks, meaning you can use them to enter trades.
The best way to trade a break, is to first wait for a break to occur, and then once you see confirmation the trend has changed – in the form of a new high or low forming – if it’s a downtrend break like in the first image, a higher low must form, and if it’s an up-trend break a lower high must form – enter a trade with a stop loss above the new high or low.
This won’t work all of the time, obviously, but you should be able to use it to get into some decent reversal trades.
The image below shows an example of a trend line trend trade as well as a trend line break trade.
Plenty of food for thought.
Note: A lower low takes a while to form on this break, so it wasn’t really suitable to enter a trade here.
Key Points On Trend Lines
- Always join price highs and lows to form trend lines and be quick at identifying trend line breaks, since reversals and price breakdowns at these junctions often come swift and hard.
- As with ALL technical analysis, never look at just one technique in isolation. Accurate trend lines are powerful, but their power is amplified significantly when the trend line bounce points are aligned with levels of support and resistance, as well as other significant price levels on the chart.
- If you are new to trend lines, some of the best advice I can give you is to practice drawing them and then monitoring what the price does when it comes back to them.
What To Do Next
Well there you have it, how to draw accurate trend lines.
More articles on the ways you can use trend Lines will be available in the near future.[thrive_leads id=’19821′]