I’m a price action trader. I like to study how price moves and behave. That’s why, for me, trendlines are one of the most important indicators in technical analysis. Today, I would like to share with you my knowledge about trendline trading.
By the end of this article, I assure you will know exactly what trendlines are, for what they are used and how to use trendlines to improve your everyday trading.
Understanding trend lines: definition
Trendlines are true zones of support and resistance. They spot buying and selling pressure in the market.
The main difference with support and resistance indicators, is that they aren’t horizontal lines.
Trendlines have a slope. We can have upward trend lines, or downward trend lines. They depict:
- buying pressure – in an uptrend;
- selling pressure – in a downtrend.
How to draw a trendline in a correct way
Draw a trendline is very simple. You need to connect at least two significant points of inflection in the market
A trendline is drawn connecting at least two significant point of inflection in the market (peaks or troughs). At this point, a trendline is only “potential”. When price retest it at least another time, we identify it as valid.
I used to consider this distinction between potential and valid too theoretical and not practical. However, this simple intuition may help you, in particular when considering a bundle of different trendlines. Our goal indeed, is not to find all the trendlines in the market, but only the most important ones for our trading activity.
Trendlines: magnets for price action!
Trendlines constitute dynamic barriers for price action: this last tends to re-bounce nearby these levels.
They interacts with price action. We have seen in my previous post that support and resistance zones act as magnet for price action. Look at the example here below:
We can have short, medium or long term trendlines. This classification is quite important not only for study purposes. The more a trendline has been valid in the time, the more it is reliable (check the following paragraphs about trendline reliability).
The psychology behind trendlines
Technical analysis is based on psychology, and trendlines trading is not an exception. Their magnetic action depends on the psychology of market participants.
But what does it mean in practice? The answer it’s simple. Let’s consider the same example proposed before:
We are in an uptrend, in which price moves higher. Where do you think traders will enter in action? Simple, when price retest the upward trendline. These indeed, are the safest zones in which to enter into a continuation trade (yellow circles in the above chart).
In these zones, there are clusters of buying orders: when price retrace to these zones, the results is that it bounce back into the opposite direction. We can say the opposite for a downward trendline of course.
This action continue at least until a breakout occur in the market. But how to spot a true trendline’s breakout?
When a trendline is invalidated?
When price break a trendline, we say that this last has been invalidated
When price break a trendline, we say that this last has been invalidated. I have already discuss with you about the different methods for understand if a breakout is valid or not: here however, I would like to discuss with you about something more specific to trendlines trading.
A broken trendline inverts its role in a similar way as seen for support and resistance trading: a broken trendline of support turns into a resistance and vice-versa.
For this reason, we expect a retest of the broken level by price action. This could represent a good entry point for a reversal trading (see the following paragraphs about trendlines trading strategies).
Understand trend lines: elements for trendlines reliability
I hate confusion. That’s why I want to focus only on what really matters.
In this paragraph I would like to introduce you what I think are the most important drivers for determine trendlines reliability.
Not all the trendlines are equal. They have different influence on market and price action. Our job is to find the best ones, in order to understand how they will affect the decisions of market participants.
First element, is time dimension. The more a trendline has been present on the market, the more it has been evident to the participants of that market.
Second condition is the number of the retest, without the occurrence of a valid breakout. This means that market participants are highly aware about the existence of this level, and place their buying and selling orders nearby these zones.
Other important elements for trendline reliability are:
- Clarity of price retest – the more a price retest is precise and evident in the market, the more its participants are aware about the existence of a trendline;
- Confluence with other hidden indicators – like Fibonacci or Gann levels;
- Degree of ascent or descent – If trendlines are too sharp, (let’s say above 50°), we can say that price action may be non sustainable in time. Here below you can see an example referring to bitcoin.
An additional consideration, in common with all the technical indicators, is time-frame of use; trendlines clearly visible and so traded on a weekly chart for example, have more impact on price action and traders decisions than structures formed on a 15 minutes chart.
Trendlines trading: A continuation strategy
A continuation strategy consists in enter in the market in the direction of the underlying trend. By far, these kind of strategies are the safest ones, since you’re not going against the market.
Trendlines may help you to spot the best entry point in the market. Let’s consider the example below. When price retest the downside trendline, we have an additional opportunity to enter in the market in the direction of the trend.
In these points (yellow circles), we are able to enter in a trade with a higher risk-to-reward ratio: this means that your risk is contained with the respect of what you might obtain.
If you are conservative, you can refine this strategy to include additional conditions before to actually enter in a trade. In the example below, we short the market only if there is a confluence between a price retest of the downward trendline and a previous market structure (support or resistance).
Trendlines trading: a reverse strategy
Lines of trends are extremely powerful even for spot major changes in the market. In the example below, we can notice that the breakout of a strong downward trendline, anticipate a change in market behaviour.
The long-standing downtrend, is broken and price is ready to reverse its action. Again, even in this case the confluence with a retest of a previous level, identify a good entry point after the breakout. We can notice indeed that price takes a bit of time before to actually start is run: in the yellow circle on the right we can see some candles of consolidation.
What we have learned today
Today we’ve discuss about trendlines trading, a powerful methods for analyse price action by technical traders.
You should now be able to:
- Understand what trendlines are;
- draw trendlines in a correct way;
- understand the psychology behind this indicators;
- spot the most reliable structures in the market;
- find the best entry points in the market, both in a continuation or in a reversal perspective.
Did you enjoy this content? I hope so. See you next time!