Welcome back everyone! After the previous post about support and resistance, I believe that it will only be appropriate to talk about trend lines. Over the series I have used the phrase trend reversal, trend continuation or up/down-trend. Some of you may have understood entirely, or at least partially about trend lines. For the benefit of everyone, especially those who are very new to investing, I will break down everything you need to know about trend lines in this post, so keep on reading.
What is a trend?
In day to day basis, we use the word “trend” to describe the general direction of something that keeps changing e.g. fashion, food or holiday destination. Despite the seemingly random fluctuations, there is always a general direction that can be deciphered from a greater perspective.
A similar idea can be applied when we are looking at price charts. The price might seem like it is fluctuating aimlessly, however if we adjust the time frame and look over a longer period, we may be able to see a certain general direction where the fluctuation is going. Once we manage to spot the general direction and plot a line according to the direction, there we go, we get a trend.
How is it formed?
In most cases support and resistance can be formed by connecting numerous up-fractals or down-fractals. What are fractals? Fractals refer to the turning point candlestick, either the highest or lowest point. Up fractals are surrounded by lower candlesticks whereas down fractals are surrounded by higher candlesticks. Connecting many down(up) fractals will create a support(resistance) line which therefore create an uptrend(downtrend) line. In other words, trend lines are derived from support and resistance which have been discussed in the previous post.
It takes at least two tops or bottoms to draw a valid trend line but it takes three to confirm a trend line. The steeper the trend line that we draw, the higher the chance that it will break. Furthermore, since its nature is similar to that of support and resistance, trend lines become stronger the more times they are tested. Most importantly, do not ever draw trendlines to fit the market, if they do not fit right, then the trend line is not a valid one.
If we take this trend line theory one step further and draw a parallel line at the same angle of the uptrend or downtrend, we will have created a channel. It can be used to determine potential areas to buy or sell. Generally, when price about to reach the bottom of the channel, it probably a good time to buy if we want to ride market’s momentum. When price breaks the channel too, it is a strong indicator that a trend will be formed.
Similar to trends, there are three types of channels:
1) Ascending channel (higher highs and higher lows)