Trendlines are drawn by a technical analyst and display the slope of a trend from the beginning location until the end of the trendline. A basic trend line is better than estimating the slope of a trend. Trend lines which slope up confirm uptrends, and those which slope down confirm downtrends. If the trend line is broken or the slope changes, the old line should be discarded and redrawn.
The actual trend line is based on mass market psychology. If mass crowds of traders are acting based on the same or similar trend lines, they will have generally similar reactions to those trend lines being broken. Drawing, or more accurately “finding”, the right trend line which is being used is important. This won’t be obvious until several touches of the trend line.
Accuracy is important because trend lines are treated like dynamic support or resistance levels. Prices falling on an upward sloping trend line should “bounce” and rise upwards. Prices rising against a downward sloping trend line should stop and fall downwards.
Trend Line Significance
The significance of a trend is based on several independent factors. One of the primary considerations is the amount of times a trend line is accurately touched by price action. An upward sloping trend line is drawn below the trend’s lows, while a downwards sloping trend line is drawn over the trend’s highs. Both upwards and downwards sloping lines must be touched at least twice to be drawn. Three times confirm the trend line, and four or more times merely increase its significance and accuracy. If a line is not touched more than twice it cannot be drawn.
A touch varies in its definition. When using candle sticks or bars, some people use the lowest point of the individual bar. Others use the closing price, which is technically considered more accurate. In either case, your selection must be consistent and intentional, and breaks that move through the trend line should also be considered reliably.
The lines which are touched the most have the highest accuracy, but length is also crucial. A 30-year trend which is touched 3 times and not broken is more important than a 5-week trend line touched 6 times. While the 5-week trend line is valid in the long term, the 30-year unbroken trend line is significantly more important. The more times an unbroken line has remained in place, the stronger the trend line should be considered.
The last indicator of significance is the slope of the line. One is tempted to think a steeper slope is more important, but it is incorrect. The steeper a line line’s slope, the more unsustainable the line is over longer periods of time. This reduces its long term significance even while it remains significant short term.
Ultimately the trend line with the highest degree of significance is attributed to the line which is the highest degree of support and resistance over the long term with the most touches. All of these factors should be considered when drawing a “freehand” (user created) or allowing system or software drawn lines.
Freehand Trend Lines
Drawing a trend line “by hand” firstly depends on the direction of the trend line you wish to draw. The method changes based on whether you are drawing your trend line that slopes up or down.
If you are drawing a trend line that slopes up, you need a minimum of two lows that can be connected by the sloping trend line from underneath. Your uptrend lines should be rising and touching the lows without penetration as it moves right, and supports falling prices. For an uptrend, start at an obvious valley in the trend and connect it to another low valley in the trend without a break. Two valleys touching the bottom unbroken allows a line to be drawn, but three touches are needed to confirm.
If you are drawing a trend line that slopes down, you need a minimum of two highs connected by a trend line drawn above. Your downtrend lines should be falling along the highs without penetration as it moves left, and is a resistance to the rising of price. When drawing downwards trend lines, begin with an obvious peak, and connect the line to a second peak without the line being broken. Just like uptrends, three touches from highs to the trend line are needed to confirm.
If your software platform allows you to optionally use an “extend to right” function, click yes. Your line should remain unbroken all the way off the chart’s right side, while followed by price action. If the trend stops following, pressuring, touching, or deviates away from the trend line, the trend has changed. If the extended line is broken by new lows in uptrends or new highs in downtrends, you need to redraw the line so it is unbroken while remaining accurate according to the parameters stated earlier. A break in an active trend line is a good warning sign that the trend could change in the future.
Your trend lines should stop at the highest high in an uptrend or the lowest low in a downtrend. If there’s a lower low in a downtrend or a higher high in an uptrend, your trend line should include that point. The trend line ends when you cannot continue the unbroken trend line to a new higher high in an uptrend or lower low in a downtrend.
If you are drawing trendlines you should include the entire day in the trendline. If a break occurs, drawing a second test line is better than attempting to constantly correct or change lines to find the accurate trend. If you have a close below the trendline, this might only mean an intraday break has occurred rather than a change in the trend. If there is an actual close beyond the trend line, or multiple bars continue breaking the trendline, it can be safely presumed the trend has changed.
Editing Trend Lines
If there is an actual close beyond the trend line, or multiple bars continue breaking the trendline, it can be safely presumed the trend has changed. Once the trend has changed, redrawing a trend line may be necessary. If the original trend line is too flat or too steep, you can simply redraw the entire line or adjust the ending data point to capture the changed trend. Again, it should touch two points for the line and a third to confirm. If this does not occur, your trend line is probably incorrect. If you’re having extreme difficulty tracking the trend, consider using Simple Moving Average or Parabolic Stop and Reverse indicators.
Due to their function, trend lines will never be able to capture multiple trend changes. These simply don’t function for changes in the trend or multiple moves. They’re supposed to highlight single trends moving up, or down, but not horizontal movements.
Systemized Trend Lines
Trend lines can also be based on rules or systems, and this is quite frankly the better pathway to accurately creating trend lines. A systemized approach helps eliminate personal bias, which improves accuracy. Obviously, the more personal bias you allow in your design of the system, the more inaccurate your systemized results. A fairly simple system is as follows:
For an uptrend, always draw from the lowest low to the next low before any new high. Every time a new high occurs, redraw or adjust the line to include the new low before it, touching the bottom of the previous lows. If there is no new high, you can simply extend the line as long as it remains unbroken. If multiple new highs occur without the lows touching the trendline, the trend may have accelerated and a new line can be drawn using the same procedure. Do not delete the old line, extend it to the right (or into the future) in case it becomes a future support slope when the new line exhausts itself.
A downtrend is similar, start with the highest high, and connect each new high before the lowest low. Every time there is a new low connect the trendline to its previous high. If there are no new lows, you can simple extend the slope into the future until it is repeatedly broken by a change in trend. If new lows occur without the highs touching the trendline, an acceleration in downtrend may have occurred. Extend the old trend line to the right (or into the future) and draw a new trendline that captures the acceleration in trend. The old trend line may be a resistance line for the trend.
These are simple systemized rules and are subject to change based on desirability. Like stated, the more personal bias you place in the overall system, the more inaccurate all results derived from the system will become. The goal for systemized trend lines is achieving unbiased evidence of the underlying trend, which requires eliminating bias in the system.
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