It is easier to see the trend on a chart afterit has occurred.
Trying to identify the trend as it is developingis much more difficult.
This monthly chart shows a sustained uptrendtrend, but there is a slowing of that trend toward the end.
Will the upward trend continue? Will prices begin a downward trend? Will they move sideways? The purpose of technical analysis is to applytools that provide the best chance of identifying the future direction of prices.
If wrong, these tools also control the sizeof your loss.
So, it’s imperative you don’t over complicateyour analysis with useless data or indicators that don’t add value to your charts.
Today, we’ll talk about trends, trend linesand price action and I’ll show the easiest way to analyze a chart to have a better understandingof what is really happening on it.
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First of all, the time interval is a key elementwhen identifying a trend.
Forget about 15 minutes or 5 minutes chartsand go on the daily chart.
Weekly and monthly charts show the major trendseven more clearly than daily charts.
Longer-term charts remove a large part thenoise that interferes with seeing the bigger picture.
The most successful traders and investorsstart by evaluating a weekly or monthly chart, and then apply the lines and values developedon those charts to a daily chart.
The weekly chart provides direction, whilesthe daily chart, or even the h4 or hourly charts, are used for timing entries and exits.
In order to successfully determine a trend, you must master the trend lines.
Trend line analysis is often underestimatedby traders because it is perceived as being subjective.
A trend line determines the current directionof price movement, and often identifies the specific point at which that direction willchange.
I would say that the trend line is the mostpopular and recognized tool of chart analysis.
Now, how to draw trend lines.
In an uptrend, you look to connect the lowsof the price.
In a downtrend, you connect the highs of theprice.
A valid trend line connects two or more pointsthat define the trend.
As I said before, you start drawing trendlines on higher time frames and the carrying them forward to shorter time frames.
In this way, you identify the areas of supportand resistance, the most significant levels being on the higher time frames.
An uptrend line has a positive slope and actsas support.
As long as the market price remains abovethis trend line, the uptrend is considered intact.
A close of the price below the uptrend linesuggests that a change in trend could be on the cards.
A downtrend line has a negative slope andacts as resistance.
As long as the market price remains belowthis trend line, the downtrend is considered intact.
A close of the price above the uptrend linesuggests that a change in trend might happen.
So here is a classic downwards trend line.
It connects the highest price with other priceswings.
When prices move through the trend line headinghigher, the downtrend has been penetrated.
This may end the downtrend or cause a newdowntrend line to be drawn.
In this case it was the end of the downtrend.
The trend lines are basically support andresistance lines.
An upwards trend line, drawn across the lows, is a bullish support line because it defines the lowest price allowed in order to maintainthe upwards trend.
The downward trend line, drawn across thehighs, is a bearish resistance line.
Proper use of these basic lines is essentialfor identifying the overall direction of the market and understanding the patterns formedas prices move from one level to another.
But how do you know the relevance of a trendline.
I personally have 3 concepts I look at a trendline: its length, its number of retests and its ascending or descending slope.
So, the length of the trend line is an importantfactor.
A 3-4 weeks trend is of minor importance ifthe trend lasts for 1-2 years, for example.
A break below or above a trend line with animportant length represents an important signal.
Also, a trend line is more important if ithas been retested many times.
That’s why a trend line acts like a dynamicarea of support or resistance.
Each line retest contributes to the importanceof support or resistance.
Extending the trend line after a breakoutis very important because its role of dynamic support / resistance will reverse.
This means that if an uptrend line retestedseveral times in the past is broken to the downside will become a resistance area.
Also, if a downtrend line retested severaltimes in the past is broken to the upside will become a support area.
In what concerns the slope, a very steep trendis difficult to be maintained and is therefore likely to be easily broken, even by shortlateral movements.
All the trend lines are eventually broken, but the steepest trend lines are the soonest broken.
Usually, from my experience a breakout ofa trend with a steep slope is more likely followed by a trend continuation than a reversal.
A steep trend line is the result of an acceleratedincrease or decrease in the short term.
In this case, the trend line will have a higherangle and is less likely to provide solid support or resistance.
Now, once the support and resistance lineshave been drawn, a price penetration of those lines creates the basic trend signal.
I prefer to add the additional rule that oncethe price has penetrated a trend line, it must remain penetrated for some time periodin order to confirm the new trend because most false penetrations correct quickly.
In actual trading, the price crossing thetrend line is not 100% clean.
Most often, prices that have been moving higherwill cross below the trend line, then re-cross moving higher, then move lower again.
The trend line is an important turning point, and there may be indecision that is reflected in a sideways price movement before pricesreestablish a trend.
To deal with this situation, you could doone of the following: • wait a set time period to confirm thatprices remain on the new side of the trend line.
• wait for a reversal after the penetration, then enter a trade in the new direction.
• create a small safety zone (called a bandor channel) around the trend line and enter the new trade if prices move through the trendline and through the safety zone.
Each of these techniques requires a delaybefore entering.
A delay normally benefits the trader by givinga better entry price; however, if prices fall quickly through an upwards trend line anddo not reverse or slow down, then any delay will result in a much worse entry price orno entry at all.
Unfortunately, most of the biggest profitsresult from breakouts that never pull back.
That’s the reality.
I know you want the textbook breakout, withthe price retesting the breakout level, but in some cases the price just keep on goingand never reaches the breakout area.
Now, to get a better understanding of thetrend you could create a channel with trend lines.
A channel is formed by a trend line and anotherline drawn parallel to the trend line enclosing a sustained price move.
The purpose of the channel is to define thevolatility of the price move and establish reasonable entry and exit points.
Up to now, the trend line has only been usedto identify the major price direction.
A long position is entered when the pricecrosses a downward trend line moving higher.
The trade is held until the price moves belowthe upwards trend line.
However, it is more common to have a seriesof shorter trades.
While the biggest profits come from holdingone position throughout a sustained trend, a series of shorter trades is also a viablealternative if you are an active trader.
Just be aware that trend lines using verylittle data are essentially analyzing noise and have limited value.
So before a channel can be formed, the bullishor bearish trend line must be drawn.
A clear uptrend line requires at least two, and preferably three or more major low points on the chart.
These points do not have to fall exactly onthe line.
Once the trend line is drawn, the highesthigh can be used to draw another line parallel to the upwards trend line.
The area in between the two parallel linesis the channel.
In theory, trading a channel is a simple process.
We buy as prices approach the support line(in this case the upwards trend line), and we sell as prices near the resistance line.
These buy and sell zones should be aroundthe bottom and top 10%-15% of the channel.
If prices continue through the lower trendline after a long position has been set, the trade is closed.
In a downward trending channel, it is bestto sell short in the upper zone and cover the short in the lower zone.
Buying in the lower zone is not recommended;trades are safest when they are entered in the direction of the trend.
Remember, trend following is the most profitableand consistent trading style.
The reality is that no one knows how highor how low a market will go.
No one knows when a market will move.
But we can follow a trend to increase ourchances to profit from the markets.
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Until next time.