Trend line is one of the most basic but useful tool in Technical Analysis. As its name suggests, it only works when there is a trend in the market.
1) How to draw a trend line:
As a normal line, it requires at least two points to draw a trend line.
+ In a bull market: We connect at least 2 LOWS to draw a trend line.
+ In a bear market: We connect at least 2 HIGHs to draw a trend line.
+ You can draw a trend line cut through a little bit of the shadow of a candle NOT the real body of a candle. This is a hard rule without exception. Otherwise, the trend line is invalid!
Now you can scroll down a little bit to look at some examples that show how a trend line is drawn before continuing through.
Yeah! It might seem pretty simple but to draw a correct and concrete trend line, you have to practice for a few days . Some traders, especially those learnt too much in Technical Analysis, tend to neglect the simple but very useful trend line. Don’t ever forget that all successful trading advice always have something in common: “Keep it simple! “
2) How does trend line work?
+ In a bull market: It provides a support for the price
+ In a bear market: It provides a resistance for the price
The more times a trend line is tested (touched) by the price, the stronger it becomes. In my own experience, be careful with the 6th or more test, I barely see any trend line can hold that long.
Let’s take a look of some examples:
The first chart shows a trend line drawn in the bull market. We connect 2 lows in the price to create the trend line. This line immediately provides a support for the price a few candles later ( 3 green circles). And as I said before, Support is a zone not a line. Hence, the 2 arrows mark another lows might also “feel” the support zone of the trend line. As always, this interpretation is subjective and have no absolute rule
The second example shows a very beautiful trend line in a bear market. It is tested 5 times before broken, which marks a new bullish trend until the time writing this. And as I mentioned earlier in part 1, you are NOT allowed to draw trend line which cuts through the real body of a candle. If it does, that trend line is invalid and not reliable.
3) What if a trend line is broken:
First we need to consider what is a sustainable trend line? The answer is simple: a 45-degree line is the most sustainable one. The steeper the trend line is, the easier it will be broken in a very short time. And a trend line is also more sustainable when it is tested multiple times.
Having said that, it leaves us with 2 scenarios:
+ If a steep trend line is broken: “Well! I knew it all along. Nothing to worry”. Just be prepared to draw a new trend line whenever possible or wait for another signal to act.
+ If a sustainable trend line is broken: “Alert! We were hit”. Any position in the same direction with the trend line should be immediately closed or partly closed.
Let’s look at the first example:
This is the old chart we saw above but we will go into more detailed analysis as in the real world market condition ( we are ‘blind’ in the real market. It is easy to look at the chart in retrospect and tell everything but you will not be that confident when facing the uncertainty of the future.)
The first trend line acts as a support for a very sharp rally which marks the beginning of a bull trend. The violation of this trend line shouldn’t be a red flag because it’s very steep. This break might just show the sign that the bull want to take a break after a very quick and long ride.
The second trend line is a sustainable one with 3 tested times and 45-degree angle. The break of this trend line with a very bearish candle signals that all long positions should be covered or partly covered. As you might see, the correction this time is more severe compared to the break of trend line 1. The market takes several months to stabilize and continue with the bull trend.
And we already discussed about the third trend line. As you may figure it out yourself, this trend line is very sustainable and provide critical support for this bull market. Any violation of this trend line should be a red flag for any long positions.
Now let’s come back to the PFE daily chart. We can easily spot a 5-times-tested trend line with a nearly 45 degree angle, hence a sustainable one. The break of this trend line this time doesn’t begin a correction but a whole new bull trend. So you tell me, how serious it is when a sustainable trend line is broken?
Homework :p : Open the chart of any stock or currency pair you like, try to draw the trend line as instructed in this tutorial :D. Remember to zoom in or out to get the best view so you can see the entire trend.
For users of Metatrader 4: Click Indicator -> Lines->trend line to get the trend line. Or it might be already on the main screen if you didn’t turn off the bar