How To Draw Trend Lines: You might often come across the term “The trend is your friend” while trading in the stock market. It basically means that individuals should trade in the direction of the trend the stock is moving.
Individuals can use various ways to spot trends in the market. One of the most common ways of identifying the trend in the market is by drawing a trendline.
In this article, we will be discussing how to draw trend lines on the price chart in the stock market.
What Are Trendlines?
A trendline is a distinctive line drawn by individuals on a securities chart that connects a series of prices to the market trend. These trendlines can slope downwards or upwards based on the trend present in the market.
These trendlines are used by the individuals to get an idea of the potential direction in the price of the security and also help them identify the area of support and resistance.
Why Are Trendlines Important?
Trendlines are essential to individuals in the stock market because they provide a visual representation of the security’s price over a period of time.
It helps individuals identify if a security is trending upwards or downwards by connecting two or more price points of the security.
This can help the individuals identify the support and resistance lines which in turn can help them interpret when to buy or short the security. It can even help interpret the point of stop-loss in the market.
Types Of Trendlines
A trendline is formed by connecting two or more price points on the chart on the upper end or the lower end based on which it can be categorized in two ways:
1. Support Trendline Or Upwards Sloping Trendline
A Support trendline or an Upward facing trendline is formed when the price of the security is trending in an upward direction and you are able to connect the cost of the security on the lower end for more than two consecutive points with the help of a single line.
As the name suggests, this line acts as a support level for the price of the security and can create a good buying opportunity for individuals in the market.
2. Resistance Trendline Or Downwards Sloping Trendline
A Resistance Trendline or Downwards sloping trendline is formed when the price of the security is trending in a downward direction and you are able to connect the cost of the security on the higher end for more than two consecutive points with the help of a single line.
As the name suggests, this line acts as a resistance level for the price of the security and can create a good shorting opportunity for individuals in the market.
How To Draw Trend Lines
In order for a line to be considered a strong trendline, it needs to be connected to three price points sloping in an upward or downward direction. Following are the steps to draw a trendline for security.
Initiating Point: This is the price point from which you start plotting the trendline of the security. This is the point from which an individual needs to connect at least two more price points in order to identify the trend.
Confirmation Point: This is the second price point on the chart that helps constitute a trendline. It is the price point where the security has bounced back up or down.
This is the point at which you extend the line from the initiating point and extend it further throughout the future chart which helps you form a trendline.
Validation Point: This is the final price point in the chart which confirms the validity of the trendline. While the two points are connected to each other on a speculative basis and extended further in the future, the third point helps you confirm the trend that exists in security.
When the price bounces off the trend line that has been drawn, it helps you give a better conviction of the trend pattern existing in the market.
How To Draw Trend Lines In An Uptrend
In an uptrend, the trend line on the charts is drawn based on the lower price points of the security. The points based on which the trendline has been drawn are levels where the security has bounced back up.
This trendline acts as a support line and the point when the security bounces back for the fourth time is where you can place your long position.
How To Draw Trend Lines In A Downtrend
In a downtrend, the trend line on the charts is drawn based on the upper price points of the security. The points based on which the trendline has been drawn are levels where the security has taken a downward reversal.
This trendline acts as a resistance line and the point when the security reverses back for the fourth time is where you can place your short position.
Important Characteristics Trendline
- For a support trendline, the security is considered to be in a bullish trend as long it remains above the trendline. For a resistance trendline, the security is considered to be in a bearish trend as long it remains below the trendline.
- While forming a trendline, there are situations where the candles’ highs or lows overlap. But it is important to note the trendline should not cut through the body of the candle
- The trendlines drawn using the closing price on the line chart are considered more effective on a long-term basis.
- If the price of the security breaks the trendline, the price might move in continuation of the direction of the break. If the price reverses back to the range of its old trend line after the breakout, it is considered a ‘false break-out scenario’
- The support trendline will turn into a resistance line and vice versa if the trendline gets broken.
Also Read: Most Accurate Leading Indicators – Pros, Cons & More!
In Closing
In this article, we discussed what is trendline, its importance, how to draw trend lines, and the characteristics of trend lines.
Trendlines are one of the popular aspects of technical analysis and can offer great insight to individuals trading in the securities market.
But at the same time, it is only one of the many tools used by individuals to trade and offers no guarantee of working every time. The prices of the securities can also slightly break beyond the trendlines before moving within the lines.
Thus it is important for individuals to also use other technical indicators to get a better conviction of the market which can help them place better entries and stop losses.
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