Drawing Valid Trend Lines

Written by Edward Gonzales

March 7, 2021

Many traders are familiar with horizontal support and resistance zones, but some traders find it difficult to use trend lines. This is rightfully so, since trend line analysis requires a little more discretion on the part of the trader. Trend lines are useful in helping you determine the trend, as well as the strength of that trend.

If you follow the trend, half the battle is already won. When the price is in a trend, the probability that price will move in the direction of the trend is higher. There are three phases in the market: uptrends, downtrends, and consolidation. The combination of the three phases completes one market cycle. 

Uptrends

On an uptrend, there is a higher probability that prices will go up. An uptrend is defined by higher highs and higher lows. In an uptrend, you must buy the dip, never buy the high.

In general, we always want to go long on an uptrend, when the price dips. We never want to buy at the swing highs because we know that the price must eventually dip before continuing to move higher.

Downtrends

On a downtrend, there is a higher probability that prices will move lower. A downtrend is defined by a series of lower highs and lower lows. In a downtrend, you must short sell the rally, never short at the low points.

We always want to sell, or go short, on a downtrend. The ideal place to sell is when the price has a rally upwards. We never sell at the low points because the market tends to rally up before moving back lower.

Consolidation

In a consolidation pattern, prices move sideways between a support zone and a resistance zone. Support & resistance represent key price levels where the forces of supply and demand meet. Eventually, price breaks out of the consolidation. We never know until it happens.

I prefer to trade with the trend than to trade in consolidation ranges. I just want to give you an idea of the three market phases for you to be able to understand market conditions when doing your technical analysis. When you are looking to make a trade in any currency pair, you first need to identify if the currency pair is in a downtrend, an uptrend, or a consolidation. You do not want to take a long position in a downtrend, nor do you want to take a short position in an uptrend. 

Market cycles 

A market cycle is a combination of all three market phases. First, a market consolidates. Then, a market breaks out either in an uptrend or a downtrend (during this breakout is the best time to go long or short, once the trend has been identified). After an uptrend or downtrend is exhausted there is a trend reversal, which leads to another consolidation period before the next breakout. This is a market cycle. Now that you have seen the three market phases, let’s take a look at a few photo examples of market cycles.

This is the same photo with and without text. Take a look at how the price consolidates, then breaks out into a downtrend, then reverses to an uptrend. It is likely that after the uptrend, the price will revert to a previous support or resistance zone. If you can  identify these market cycles and trade precisely within them, you will be more consistently profitable. Here are some more examples of market cycles.

Drawing Valid Trend Lines

Now that you know the three market phases, let’s talk about trend lines. A trend line is a straight line that connects two or more price points and then extends into the future to act as a support or resistance zone. Many of the principles applicable to support and resistance zones can be applied to trend lines as well.

An uptrend line has a positive slope and is formed by connecting two or more low points. The second low must be higher than the first for the line to have a positive slope. Note that at least three points must be connected before the line is considered to be a valid trendline. Uptrend lines act as support and indicate that net-demand is increasing even as the price rises. As long as prices remain above the trend line area, the uptrend is considered solid and intact. A break below the uptrend line area indicates that net-demand has weakened, and that a trend reversal could happen.

In this BTC/USDT chart, you are able to see a clear uptrend. This trendline is connecting the lows of the currency pair, showing us that price is trending upward. This trendline serves as a dynamic support zone because the support levels move up as the trend also moves upwards. As you can see in the photo, price tested the trendline multiple times without breaking it, and proceeded to reverse back up each time. Once price fails to break through the trendline for the third time, we know that the trendline is valid and we can start going long on future price tests because we know there is a high probability of a price reversal.

Now let’s talk about downtrend lines. A downtrend line has a negative slope and is formed by connecting two or more high points. The second high must be lower than the first for the line to have a negative slope. Remember that at least three points must be connected before the line is considered to be a valid trendline. As long as prices remain below the downtrend line area, the downtrend is solid and intact. A break above the downtrend line area indicates that net-supply is decreasing and that a trend reversal could occur.

In this BTC/USDT chart, you can see a clear downtrend. You can see that there are two trendlines, ignore the bottom trendline that’s connecting the lows for now, and only focus on the downtrend line at the top. This downtrend line serves as a dynamic resistance zone because the resistance levels are moving down as the trend also moves downwards. As you can see in the chart, price tested the downtrend line multiple times without successfully breaking it and proceeded to pull back down each time. After the third failed trendline test, we could have started to short this currency pair because there is a higher probability of a reversal.

But as you can see, this example has two lines because price has formed a channel – a descending channel to be more specific. A descending channel is the price action contained between two downward sloping parallel lines. Lower highs and lower lows are both technical signals of a downtrend as we have seen. Trendlines frame out the price channel by drawing the upper line on the lower highs (serving as a resistance zone), and the lower line on the lower lows (serving as a support zone). A lower low below a descending channel can signal continuation. A higher high above the descending channel can signal trend reversal.

Now that the channel is drawn, we can clearly see that price struggled to break its support and resistance zones for an extended period of time. A general rule when trading channels is that the bottom line, which serves as support, is a buy zone, and the upper line, which serves as resistance, is a sell zone. That said, in the early stages of your trading journey I advise you not to go against the market trend.

For example, if you can correctly draw a descending channel, it means the market is trending down. When you take a short position at the top of that channel it means you are going with the trend and thus, have a higher probability trade. That said, taking a long position at the bottom of the descending channel means you are counter trend trading, which involves a lot more risk.

In uptrends, you can draw ascending channels as well. I won’t go too in detail on this because an ascending channel is essentially the same as a descending channel, but with the rules reversed. Below is a photo of an ascending channel, just so you can see what it would look like (don’t focus on the RSI or CRSI indicators right now, we will go over those  later). Keep in mind that finding valid channels are rare and harder than finding valid trendlines. 

The most important takeaway is to understand how to identify a trend, how to draw trendlines, and how to trade with the trend. If you can use candlesticks to identify trends and then trade with the trends you will have a higher probability of being successful in your trades. Visit our website to find more blog publishings and educational content.

By viewing any material or using the information within this publication you understand that this is general education material and you can not hold any person or entity responsible for loss or damages resulting from the content or general advice provided here. Trading cryptocurrency has potential rewards, but also potential risks. You must be aware of the risks and be willing to accept them in order to invest in the markets. Only trade with funds you can afford to lose. This publication is neither a solicitation nor an offer to buy/sell cryptocurrency or other financial assets. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed in any material on this website. The past performance of any trading system or methodology is not necessarily indicative of future results.

Written by Edward Gonzales © Crypto University 2021

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