Types of Trend lines: Trend line trading strategies
By Yuriy Bishko Updated November 21, 2021
Trend strategies are popular among experienced traders, so knowing how to draw trend lines becomes one of the tasks that beginners should learn. This will help them to identify the existing trends on the market.
Trend lines are a graphical tool used by traders since the inception of technical analysis (TA) and clearly demonstrate where the quotations of a particular asset are headed. According to the theory of Dow, the founder of technical analysis, the price on the market always moves within one of the three main trends. This statement is true for any financial market, be it stock, commodity, currency or cryptocurrency.
Periodically, the chart goes up, then for some time a flat is established in the market. But it can be absent, then after the upward movement the downward movement starts at once. The opposite situation when the downtrend is replaced by a flat or ascending movement is also fair. The drawn trend line is used by specialists, it shows in what direction the price moves.
The longer there is a trend line on the market, the more powerful the reverse movement will be.
For example, at first the asset becomes cheaper every day, the chart goes down. But when the situation changes, there is investor interest in the asset. They begin to buy it, it rises in value.
The chart moves up, reaches the resistance line, breaks through it, and then rushes forward. And so an uptrend develops. How long it lasts depends on the market trend, the news, and other factors that affect the value of the coin.
If price has been moving in the same direction for several weeks, when looking at the four-hour or daily chart, the trader will notice that a resistance or support line is forming. But in the case of a recent trend change, a new movement is just beginning to form, the limits have not yet been formed. Therefore, it is necessary to wait for a pullback.
Pullback-free trends are rare. More often than not, when the price reaches a support or resistance line, it bounces off that line. Such a pullback usually takes about 30% of the main movement. Taking it into consideration, trend lines can be drawn.
A Crypto trader should learn to find out where the market is moving.
Trend lines can be drawn as follows:
- 1. If the movement is upward, the support line is drawn on the chart minimums. Above, parallel to it, the resistance line is located.
2. When the movement is descending, the resistance line is drawn on the maximums, and the support line is drawn parallel to it.
3. In the case of a flat movement, the minimums are used to draw a support line, and the highs are used to draw a resistance line.
Efficiency of trend lines
You should know how to draw a trend line correctly. Although it is believed that trend lines can be drawn on 2 points, the more of them, the more stable resistance level can be called. The same is true for the support level.
But it happens that the price behaves in such a way that even 2 points cannot be found for drawing. In this case it is not necessary to draw, it is necessary to wait for the next maximum or minimum to be formed.
The trend should be clearly defined, so there is no need to make up anything. Beginning traders can be guided by the following rule: the line is drawn on 2 points, and the third should serve as a confirmation.
Location of contact zones on the line
Many novice traders wonder where the contact zones should be located. The distance depends on what timeframe is selected. It matters how the price moves, subjective preferences of a crypto trader also have an effect.
If extremums are close to each other and a trend line has been drawn on them, it does not mean that the forecast is correct. It is necessary to strive to have points 1 and 2 marking extrema at a distance from each other.
Rules of construction
It is important to understand how to build a trend line on the cryptocurrency or any other market. According to Dow Theory, to build a trend line, it is enough to connect 2 local extrema – minimums for an uptrend and maximums for a downtrend. However, after such a construction, the entry points are not looked for yet, and they wait for the confirmation of the trend in the form of the 3rd reference point. Once three local extrema are formed in one direction, they believe the trend is stable and work along with it.
Further, the more rebounds are formed from the lines of one of 3 trends, the stronger it is considered. That is, the presence of more than 3 pivot points when drawing a line indicates the strength of the trend developing on the market.
Another important rule to understand before drawing trend lines is the following: the anchor points should not be located very close to each other. If they are located next to each other, the trend identification will be inaccurate, and trading along it will become unreasonably risky.
The slope is also considered during drawing. The steeper the slope angle is, the faster the price moves. The angle of slope determines whether the price slows down or speeds up. Breakout strategies and trend reversal trading systems work at the moment of acceleration, but the risk of using them on the cryptocurrency market is higher than on the stock or currency market. Therefore, do not forget to be cautious.
Resistance and support
Usually, when constructing trend lines, they are drawn through both highs and lows at the same time. The result is a channel where the bottom line is support and the top line is resistance. Every time the price approaches support or resistance, look for entry points to reverse.
If the price breaks through the level of resistance or support, they wait for confirmation of the signal and open a deal in the direction of the breakdown. Confirmation is understood as a situation when the price crosses the level, then comes back to it on the pullback, and then continues to move in the direction of the breakout. In this case the level we have broken through is called a mirror level, i.e. it was support at first, but when the price broke through it and then returned to it on the pullback and continued to fall, it changed its role to resistance. That is why they say it is a mirror.
The slope angle of the trend line
There is an observation that the less steep the slope angle of a trend line, the stronger the trend and the more likely it is to persist. If such a trend line is broken, it is more probable to expect some consolidation (sideways or a slight counter-trend) and continuation of the current trend, rather than a reversal.
And vice versa: if the trend line is steeper, it means the trend is more likely to be short-term and, in case the trend line is broken, a price reversal and the start of a new trend is very likely.
It can be explained by the fact that a calmer trend is more “conscious”, caused by objective reasons – economic factors and the like. But a sharp trend with a steep angle of slope of the trend line is some kind of short-term excitement, most likely not related to global factors that can create a new long-term trend.
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What indicators to use
Since the strategy under consideration involves trading along the trend, it would be logical to use trend indicators:
- - MA (SMA, EMA, etc.);
- - Stochastic RSI;
- - MACD.
The dangers of using trend lines
Trend lines are a tool well known to all participants. As soon as price approaches them, market participants prepare for a pullback trade. This is well known to manipulators, who often set traps near such key resistance and support levels.
The mechanism of the traps is simple – the price does not bounce back, but breaks through the level, which entices them to enter the breakout. But then it reverses and goes in the opposite direction, thus deceiving the crowd. Such a formation is called a false-break. It works well in any market, including the cryptocurrency market. That’s why you need to learn how to identify it and use it to your advantage.