What are Trend Lines?
In addition to the levels of support & resistance, trend lines are equally as important in technical analysis. Many of the principles that apply with support and resistance levels can be applied to trend lines as well. Trend lines are a visual representation of support and resistance in any time frame. Trend lines are easily recognizable linear lines that traders draw on candlestick charts to connect a series of prices together or show some data’s best fit. The resulting line is then used to give the trader a good idea of the direction in which an investment’s value might move.
A trend line is a linear line drawn over pivot points, high or low, to show the prevailing direction of the share’s price. Trend lines can be identified as either an uptrend or a downtrend.
Uptrends & Downtrends
An uptrend 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. Uptrends act as lines of support and indicates demand is increasing even as the price rises. As long as prices remain above the trend line, the uptrend is considered valid. A break below the uptrend indicates that sellers have overtaken the buyers and a change in trend could be imminent.
A downtrend has a downwards slope and is formed by connecting two or more high points. The second high must be higher than the first for the line to have a downwards slope. Downtrends act as lines of resistance and indicates that demand is decreasing as the price is falling, which is very bearish. As long as prices remain below the trend line, the downtrend is considered valid. A break above the downtrend indicates that buyers have overtaken the sellers and there’s a great possibility there could be a change in trend to the upside. In this next section, we’re going to take a look at an example of an uptrend and a downtrend on the chart of Bitcoin.
Taking a look at the 1W time frame of Bitcoin (BTC), the top market cap cryptocurrency, we can identify one major uptrend & downtrend. Analyzing this chart from a top-down standpoint, we can first identify where the start of the uptrend is placed, igniting the wick up to all time highs ($18,953 – $19,666). The start of the uptrend is formed in March 2017 and connects to the swing low of the December 2018 dump for the second point. This trend is drawn from the body of the candles, not the wicks (in order to get a more accurate representation of the trend). Two points on a trend line forms the trend, while the third touch confirms that trend. We see the third touch of the uptrend shortly after the coronavirus dump down. This uptrend acted as a market bottom / support for the price of Bitcoin, and swiftly proceeded to head upwards to new highs shortly after.
Looking now at finding the downtrend that is holding back the price of Bitcoin, we identify the top wick of the swing high from the 2017 bull run around the $19,600 level and connected the second point to the top wick of the swing high from the 2019 summer bull run around the $14,200 price range. This third touch was not confirmed on the chart until after the coronavirus dump, following the third touch confirmation on the uptrend. As soon as Bitcoin 1st touch rejected, it was looking to break out of this downtrend. Shortly after rejecting, BTC came back and spiked to new-found highs.
Psychology in Trend Lines
Buyers will often purchase large amounts of a financial asset once the price starts to fall toward a major uptrend line, which makes it more difficult for the shares of that asset to fall below the trend. On the other hand, sellers start to sell off an asset as it moves towards the top of the downtrend, making it difficult to move past this upper level as well. It is the increased buying and selling pressure at these levels that makes them important trend lines, and in many cases, major psychological points as well.
Trend lines created by psychological levels aren’t necessarily the strongest levels and can’t guarantee those psychological levels are worth marking out on the chart. All of the levels marked on the chart are found on the chart and the chart only. The market makers are very good at creating the random walk in the market and understand that we understand these trend line price movements, so they make it difficult for us on purpose. That is why I don’t mark out psychological levels based off the psychology, and solely base all of my levels based on what i’m given on the charts.
The Importance of Trend Lines
Trend Lines in technical analysis are important tools and often referred to as the backbone of technical analysis, because it can be used to make trading decisions and identify when a trend is reversing. For example, if a trader identifies an important downtrend that has been tested several times but never broken, he or she may decide to take profits as the financial instrument moves toward this point because it is increasingly less likely that it will move past this trend. Chances are the price of the asset will reverse back downwards and you’ve stumbled upon yourself a local market top.
Uptrends and downtrends both test and confirm trends and need to be monitored by anyone who uses technical analysis. As long as the price of the share remains above the uptrend or below the downtrend, the trend is likely to continue. It is important to note, however, that a break beyond an uptrend or a downtrend does not always indicate a reversal in the trend. Taking a look again at our Bitcoin example, we can see that after the coronavirus dump down in March 2020, Bitcoin wicked below the uptrend for a brief moment, but then regained the uptrend and reversed to higher highs.