A trend line is a line on a chart, which connects at least two price points in the market, that reflects the overall direction in which that particular market is going. When we find the overall direction a market is going, we can apply our strategies. The majority of the time, we want to trade with the trend. When we trade with the trend we make more profits in less time.
Applying Your Technical Analysis
Most Trading College students use the Pro-Trading System, a system that fires signals telling you when the markets are directional, giving you entry points and exit points (i.e. your stop loss levels and targets). If you apply your technical analysis to this system, in other words, you use your trend lines to inform your trading choices, then you reinforce it. The PTS does most of the work for you, but getting really good at technical analysis will increase your chances of making successful trades.
Identifying A Trend Line
We use candlesticks to read price-action. For an up trend you are looking to connect a minimum of two low points in the market. With a down trend, you want to find a minimum of two high points on your candlesticks. Many people make the mistake of using the opening or closing price of the candlestick, which is incorrect. You should be looking for the low and high points on your candlestick (depending on whether you are looking at an up or down trend respectively), in other words the lowest or highest price that was reached in that period.
Confirming A Trend Line
Traditionally, to confirm a trend line, you need a minimum of three points connecting a line going in one direction. When you draw a line with two points on it, you have a potential trend line. This is only confirmed when the price touches it for a third time; so think “third time lucky”! The market can go up and down several times before that third touch.
When you get more experienced at drawing trend lines, you can start playing with formations, such as channels and triangles. This is where you take two trend lines and, depending on their angles, start to find patterns. For example, when you have two parallel trend lines you will see a channel, or when you see prices start to contract, you will see the trend lines begin to create a triangle.
One thing to look out closely for when trying to trade from a trend line is a fake breakout. This is when the market seems to penetrate your trend line but doesn’t have the strength to do so. Once you have drawn a trend line, as the market continues to move up and down, the price will often come close and seem to break through that trend line, but will often bounce back in the opposite direction. To confirm a real breakout, it’s best to follow the RULE OF THREE. Once the trend line has been broken, the price needs to close below the trend line (if you are looking at an up trend, and remain above it if you are looking at a down trend) for three candlesticks before you confirm the breakout of the trend line. So if you are looking at an hourly chart, you need to wait for three hours. If you trade using a daily chart, you would wait for three days before confirming you haven’t witnessed a “fake breakout”.