Introduction to Trend Lines
One of the most important tools used in technical analysis while trading in the crypto, forex, commodity or any market are trend lines. What are trend lines? How to draw appropriate trend lines and interpret them? What strategies could be used with it?
This article focuses on discussing the above mentioned questions on trend lines and a lot more.
What are trend lines?
We often see that the price of a certain cryptocurrency lies in a certain price range. This range can be seen through horizontal price levels marked on the price charts and are called Support and Resistance. Trend lines are sloping lines that are drawn by joining the dots on the price chart to figure out which direction the price has been moving in that time span and which direction it will probably go next i.e. uptrend or downtrend. Often they are confused with support and resistance. You must be careful that support and resistance are always horizontal lines. The trend line which touches all the lows is called a supporting trend line and is completely different from what a support means. Trend lines are mostly used by traders as a momentum indicator to get a confirmation on the price action.
Drawing Trend Lines
Let us take the example above to understand how traders can draw trend lines on price charts on CoinDCX’s platform or on any other platform. To view the price chart all you need to do is select the crypto pair or asset you are interested in. While the trends are easily observable, it is important to draw the trend lines as it helps traders in understanding the support (in case of an uptrend) and the resistance (in case of a downtrend). As a reminder again, these support and resistance for the trend line are different from the horizontal support and resistance lines. Trend lines can be drawn using different time frames. It all depends on the purpose of drawing them. While price movements might show an uptrend in the hourly chart, there might be an overall downtrend in the daily chart. We have taken the hourly chart in the above example. A 4 hour chart for the same pair looks like the image below.
Trend lines are drawn in a trending market to connect the swing highs and lows in a price chart. For an uptrend, as seen in the image (refer to the hourly chart), we see that the price goes up (called the run) and reaches the swing high before a pullback to reach a swing low. An uptrend leads to higher highs and higher lows whereas a downtrend leads to lower highs and lower lows.
A trend line is usually created by joining 2 swing highs or 2 swing lows. Experts always suggest that connecting it to a third point makes them more valid. You must always extend the line beyond the points to predict the movement of price in future. The hourly chart in the above image shows that there are four or more points that have been connected indicating a valid uptrend.
It is not always necessary to have a trend in a given market. If you cannot spot a trend, do not try to impose one. It is also not feasible to draw a trendline when all the candles are red or green as it does not make sense.
An important question that most people get stuck at is whether you draw your trend line through the highs and lows, through the opening and closing price or through the candle body. As most experts would suggest, try to draw your line in an angle that lets you touch the most highs, lows, open and close values. The more the number of points touched, the more reliable the trend line is. It would be better if you could avoid drawing trend lines that intersect the candle body.
Interpreting Trend Lines
The reason why we draw a trend line is to signal a possible change in momentum. In an uptrend, a change in momentum happens when the price breaks the supporting trend line. Similarly for a downtrend, a change in momentum takes place when the price breaks the resistance trend line. The reason why we mention a change in momentum and not a change in trend is that, breaking of a supporting trend line or the resistance one might mean that the trend has become lesser or more significant (the slope of the trend line then changes). But a break in trend might also mean that the trend has reversed. Traders must therefore use other indicators in order to solve that problem.
Trend lines help in determining the possible areas where trading volume increases. These areas are closer to the trend lines where many people enter new trades. That is because traders use trendline breaks as trading signals to trade against the trend. Once the price has broken the trend, traders search for a confirmation before placing their trades.
An important point about trend lines that is often ignored is its slope. While a smaller angle means a weak trend, steep slopes mean strong trends. It is not always necessary that price movements are huge and hence the slopes of trend lines are usually low. An increase in the slope of a trendline, signals an increase in momentum while a decreasing slope implies a decrease in momentum.
Trend lines provide us with information about the demand and supply for the particular cryptocurrency. An upward trending market means that people are willing to pay a higher price for the crypto than its existing market price. An opposite explanation could be given for a downward trend.
Lastly, it is important to note that, the longer a trend line is respected, the more important it becomes. This means that a trend line that has been valid for the last 6 months will be more important and reliable than the one that extends over a couple of weeks.
If trading short-term or swing trading, trend lines can be used as a price confirmation along with information available from other indicators. Decisions should not be made based on the trend lines only as many times there are false breaks too. Trend lines are more reliable and effective in the longer term. It is also important to note that drawing trend lines can be monotonous and time consuming. Draw them only when it is absolutely necessary. Traders sometimes even skip using trend lines and use the moving averages and the RSI instead. Traders must therefore use other indicators like MACD, RSI , fibonacci retracement, moving averages and other reliable indicators along with the trend lines while trading.