Trendlines in trading charts explain how prices are moving or breaking out. They connect the dots between price points to reveal the direction in which an asset’s price is moving. But how do you identify these trendlines? Read on.
This article in a glance:
- Trendlines connect multiple price points over time to show the overall direction of an asset’s price.
- They help traders identify support and resistance levels, and price momentum.
- Breakouts are price movements outside of an established trend. They indicate a short-term or temporary move against a prevailing trend.
What is a trendline in trading?
Trendlines connect multiple price points over time to give the trader an idea of how prices may move going forward.
Let’s say the price of an asset went from 20 USD, to 22 USD, and then 25 USD. By drawing a trendline that connects these prices, you would have an upward-sloping line, and therefore, can assume that prices may increase going. If those prices were reversed, the trendline would be sloping downwards, showing a bearish trend.
That’s a simplified example of how trendlines work. Remember that prices fluctuate. Use trendlines in combination with your knowledge of price patterns and other technical analysis indicators to get a more realistic picture of how prices may change.
Moreover, the time frame you select when drawing the trendline also influences what the trend tells you. You may see a lot of fluctuation in a 1-minute time frame, for instance, but an hourly time frame may have a stronger indication of a bullish or bearish trend.
What do trendlines indicate?
Trendlines visualise the general direction in which prices are moving. They also help traders understand the levels that prices are struggling to move beyond, i.e., the support and resistance levels. This information informs the trader about the chances of a trend continuation or reversal. This further aids the trader to decide if to go long or short, and when to enter and exit these positions.
Types of trendlines
In trading, there are three key types of trendlines:
Uptrend: These trendlines connect higher lows, indicating that prices are moving upwards.
Downtrend: These trendlines connect lower highs, showing that prices are now falling.
Sideways: When buying and selling pressure is roughly equal, the price points move in a horizontal fashion, meaning that prices are neither bullish nor bearish.
Theoretically, trendlines must connect a minimum of three price points to be considered a valid trend. The more connected points for the trend, the stronger the conviction, and the more meaningful a trend break is.
Trendline trading strategies
Based on your analysis, trendlines can tell you whether to buy an uptrend or sell a downtrend. When developing a trendline strategy for forex or any other financial instrument you are trading, check the following two factors:
Trendline bounce: Once you have established the trendline, prices may hit this line and bounce back, indicating a continuation of the trend.
Trendline breakouts: This trendline strategy allows you to establish short-term breakouts and use them to trade against the long-term trend.
What is a breakout in trading?
Breakouts are price movements outside of an established trend. They indicate a short-term or temporary move against a prevailing trend. This movement against the norm may only be temporary but it can be used as part of a breakout strategy.
Types of breakouts
Breakout areas can be identified using trendlines. The three main types of breakouts are:
Reversal: When prices go against an established trend, it’s known as a reversal. Instead of the prevailing trend continuing, the direction changes.
Consolidation: When the price of an asset has been trending in a certain direction for a long period of time, plateaus may occur. These plateaus do not indicate any clear price direction, and prices trade in a sideways trend.
Triangle: A triangle breakout can be described as a false breakout. The price moves against the prevailing trend but, instead of continuing in the new direction, it reverts back, thus creating a triangle pattern.
Breakout trading strategy
Breakout traders make their trades when prices breach support or resistance levels, assuming that these prices will continue to trade away from support or resistance. To understand if prices are close to breaking out, traders may use technical analysis to see what the indicators are showing, and what chart patterns are forming.
There is no guarantee that when prices breakout, they will trend in the new direction. However, tying trendlines and breakouts together helps to establish vital information, such as support and resistance levels, momentum, and potential trend reversals or continuations. This information, along with tools such as take profit and stop loss orders, can help traders buy and sell with more success, while minimising potential losses.
This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorised to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.