Trendlines in trading

Trendlines are used when trading the financial markets to define an uptrend or downtrend of an asset’s price. They are a type of technical analysis, which many traders use to monitor price movements of a financial instrument in order to predict market sentiment. A trendline is sometimes referred to as a ‘trend support line’ because it shows the direction of a trend and it acts as a support line.

Trendlines are displayed through candlestick charts, which is the most common chart type in trading. As technical analysis trendlines can predict the direction of the market, they are very useful for traders when analysing an asset that they plan to trade in the near future. They can show when the security’s price is rising during a bull market or falling during a bear market, helping traders to build a more informed trading strategy based on past and current price action. Learn about the basics of trendlines and how to use them on our Next Generation trading platform in this detailed guide.

Trendline analysis

The troughs and peaks of trendlines represent support and resistance levels in a preferred period of time, which are driven by supply and demand of a security. Support highlights a price level on the candlestick chart that is under the current market price. If the buying interest of a security is strong enough to overcome selling pressure, the price will halt at this low point and start to rise again. Conversely, resistance highlights a price level on the chart that is above the current market price. This means that the price may start to fall again against an uptrend. Horizontal support and resistance levels are sometimes drawn when there is repetition of a price rising and falling to the same mark on the chart, to show that the market is struggling to move past this trend.

Trading with trendlines is useful in any financial market, whether this be forex, stocks, indices or commodities. However, some markets and assets are more volatile than others and this means that they may have less clear trendlines that fluctuate more often.

What is a trendline in forex?

Trendlines are one of the most popular methods of technical analysis within the forex market. This is because many forex traders focus on price action and quick trading results, rather than studying other fundamental factors that are more applicable for long-term trades, for example, within the share market. Using a forex trendline strategy to identify past price action, as well as support and resistance levels, is a quick and efficient way of predicting when and where to enter a position.

Trendlines are particularly effective in forex trading for short-term strategies, such as forex scalping and day trading. In these strategies, traders attempt to profit from small but frequent price movements in the volatile currency market. They look to buy currency pairs such as EUR/USD at the start of an uptrend, and sell during the peak of the trendline, or at the beginning of a downtrend. Short-term forex traders tend to focus on price action only, using trendlines to predict market sentiment of buy and sell pressure from the previous day.

Trendline example

Traditionally, uptrend lines appear by drawing a straight line through a series of ascending higher troughs (lows). With downtrends, trendlines form by drawing a straight line through a series of descending lower highs. It is usual practice to join the highs or lows (wicks) of the candlesticks and not the closing prices.

A trendline (uptrend) set through the lows

A trendline (downtrend) set through the highs

Trendline channels

Trendline patterns can be observed through the use of channels. A channel is formed when an asset’s price moves consistently between two parallel trendlines. The upper trendline attaches the swing highs together, whereas the lower trendline attaches the swing lows. Trendline channels can be ascending, descending or horizontal on the chart, if the asset’s price is not changing. Whereas a single trendline represents either a support or resistance level for an uptrend or downtrend, channels show both levels.

By drawing trendline channels on a candlestick chart, traders can identify buy and sell points for a security, as well as knowing where to place execution orders, such as stop-losses, in order to avoid loss of capital. As you can guess, the longer the channel lasts, the stronger the trend. This positively correlates with how narrow the channel is.

What are some rules for trendlines and channels?

Declines in price that approach an uptrend line, or price rises that approach a downtrend line, can be good opportunities to initiate positions in the same direction as the trendline.
The penetration of an uptrend line, particularly on a closing basis, is a sell signal, and the penetration of a downtrend line is a buy signal. Normally, analysts apply a minimum percentage price move (1% breach on a stock, for example) through the line or a minimum price move.

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According to the first rule, as price approaches an uptrend line, the trendline tends to act as a support, so you could buy as price approaches the line. The line must not be breached. If a trendline is cut through, the support level has been breached and we could act as we would if it were a normal support break.

Conversely, downtrend lines tend to act as resistance. Traders could sell as the price approaches the line, and again, it must not be breached. In the chart below, you will notice our entry points would be chosen with this in mind, providing cheaper buy-in levels in an uptrend, nearer the trendline; and in a downtrend, providing higher levels to sell into a downtrend.

Setting orders using trendlines in a downtrend

The 'sell' points in the above chart represent the ideal sell orders, which would tend to cluster near and underneath a downtrend line. The reason they have to be underneath and not above is that a downtrend line acts like a resistance line. Price action above the line is called a 'technical breakout' over the line, which means that a trader could expect a short-term spike, so they should be looking to exit short trades rather than enter them.

Trendline breakout strategy

Technical analysts are always looking out for breakouts within a trend. A trendline breakout strategy follows the idea that when a price crosses above or below a trendline, the trend has changed. If you spot a price breakout on a downward trendline, this possibly indicates the start of an uptrend, which will trigger a buy signal. In the opposite way, if you spot a price breakout on an upward trendline, this possibly indicates the start of a downtrend, so you may wish to consider selling your asset.

In this chart, you can see an example of a downtrend and trendline for most of the chart, with the ideal selling points (shown by the trendline) throughout the course of the downtrend. Then, the trend comes to an end with the break of the downtrend line and a resultant short-term spike that follows.

It is important that traders learn how to trade trendline breakouts, as this is often where their opportunities for profits lie, rather than within the stable long-term trendlines.

A trendline in a downtrend with a technical breakout

How to draw trendlines in technical analysis

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Choose which market you would like to trade, as well as an asset.
Open a trading chart from the list of securities and take advantage of our ‘draw tools’ tab. Here, you can add trendlines to your charts, as well as support and resistance lines, arrows, triangle and oval shapes, and buy and sell signals.
Study your price charts to look for trends, whether these be ascending or descending, and determine where you should enter the position and where you should exit.
Place a trade, taking advantage of our execution types, such as stop-loss and take-profit orders, in order to minimise the risk of losing your capital through a false trend or breakout.

Changes in trend speed may necessitate the re-drawing of trendlines. This is particularly important if they are breached temporarily, only to resume the trend, as this could make the lines themselves unreliable. While penetrations of trendlines often warn of a trend reversal, a breach usually also means you may need to redraw a trendline, as shown by the chart below. It is not enough to show a trendline that works; it is important that the trend method also works.

Trendline trading system

Take advantage of our customisable charts, drawing tools and technical analysis features that are all available on our online trading platform, Next Generation. You can set up trading alerts on our mobile app for when you are on-the-go, in order to receive risk warnings if your positions are in danger of loss.

Trendline indicators

Many trendline indicators are available on both our online trading platform and the international hosted platform, MetaTrader 4. Some are available to download as an add-on and customise to suit your trading personality. Learn how to draw trendlines on MT4 now by registering for an MT4 account.

Some trendline indicators that we offer on our platform are ones that do not use a linear trendline, as shown in the examples above. For example, the simple moving average (SMA) is one of the most popular technical indicators for trend analysis across all financial markets. It is plotted as a single line on a chart and calculated by averaging a number of past data points.

Similarly, a stochastic oscillator can be used to predict trend reversals by measuring the momentum of price movements. It is a two-line indicator that works for any market, especially when combined with additional price formations, such as trendlines, wedges and other drawing tools.

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