Trendline Trading Strategy in Detail
In this article, I will discuss the Trendline Trading Strategy in detail. Please read our previous article, where we discussed Advanced Candlestick Analysis in Trading. As part of this article, I will discuss the following pointers in detail, which are related to the Trendline Trading Strategy.
- The importance of drawing lines over your charts.
- Rules for DRAWING TREND LINES
- How to Determine the Significance of a Trendline Trading Strategy
- The trend channel
- Use of Trendlines Trading Strategy
- How do you enter based on the trend line?
Importance of drawing lines over your charts:
They tell a story. They show the angle of advance or decline within a price trend, alert when a market has reached an overbought or oversold point within a trend, show trading ranges, indicate the point of equilibrium (apex), and help forecast where to expect support or resistance on corrections.
Never undertake to draw conclusive deductions from trend lines alone, taking care to weigh all of the factors (three) involved in a complete diagnosis of market action. The three factors are Price Movement, Volume, and Price Movement-Volume Relationships, which determine when and where trend lines may logically be applied} and when it is inadvisable to attempt to apply them.
What is the Trendline Trading Strategy?
The momentum of an upward movement is reflected in the angular upward climb of the vertical bars on our charts and the pace of a downward movement by their angular downward pitch. The eye may not always see the pitch of these angular swings clearly because of the confusing effect of minor irregularities of the price movement as recorded on charts. Therefore, it is frequently helpful to employ Trend Lines for this purpose. Thus, examining the accompanying charts will show how the angle of ascent or descent of prices may be visualized more clearly by drawing straight lines through the successive tops or bottoms of the price path established during the minor, intermediate, and major moves.
A support or demand Line is that line that identifies the angle of the advance of a bull swing by passing through two successive points of support. Example:- Lines A-C, D-1 in above IMAGE 1
A resistance or Supply Line is that line that identifies the angle of the decline of a bear swing by passing through two successive points of resistance (top of rallies). Example:- Line I-K and I-6 in above image 2.
An Oversold Position Line is that line that is drawn parallel to a supply or resistance line and passes through the first point of support (reaction low), which intervenes between two successive rally tops in a downtrend. Example:- Line J-L, Note that J is the first point of support intervening between the two successive tops, I and K. IN IMAGE 2
An Overbought Position Line is a line drawn parallel to a support line. It passes through the first point of resistance (rally top), intervening between two successive support points in an uptrend. Example: Lines B-E, in the above image 1
Rules for Drawing Trendline Trading Strategy
- DRAW a new trend line by connecting the start of the trend with a valid swing point.
- Adjust the trend line as price action unfolds.
DRAW a new trendline by connecting the start of the trend with a valid swing point
This means we cannot draw a new trendline without a valid swing. First of all, there must be evidence of a trend. This means that for an up-trend line to be drawn, there must be at least two reaction lows, with the second low higher than the first.
ADJUSTING New trendlines
For instance, in the case of an advance, the angle of ascent may be leisurely for a time and then become pitched more sharply upward as the original force of demand is renewed by fresh buying from the sponsors of the move and the public, and perhaps by expanding enthusiasm of bullishly inclined traders and investors. Under these conditions, we must relocate our trend lines to conform to the newly established stride.
If a steep trend line is broken, a slower trend line might have to be drawn.
Trendline analysis on a chart
It will be seen that after the reaction to (B), we can distinguish two well-defined rally tops, the first at (A) and the second at (C).
Accordingly, if we draw a straight line through the extreme tops of these two rallies, we find that the extension of this supply line to the right, across the page, helps to define the approximate limits of subsequent rallies. If, however, it can rise through the supply line with some degree of strength by either increasing volume, by a material gain in price, or both. Finally, price swing E-F successfully breaks the supply line, as both candle and volume increase.
The upswing from G enables us to establish the trend support line E-G, representing the angle, or rate of acceleration, of the first phase of the bull campaign in this stock. Extending this line to the right, we find that after a sharp run-up from G temporarily accelerates the rise, the price recedes toward this line of support in what we conclude is a normal corrective reaction. If it recedes further, we may expect the price to hold on or around this support line (H). It does hold, for on the quick further rally from G POINT, marked by closing at the high, as the price almost touches our established trend line. Thus, our trend line has given us a helpful hint in advance as to the point at which we might reasonably look for new demand (support) and the probable place where this particular reaction should end.
After the markup from H POINT, we must readjust our trend support line because of the increasing momentum of the rise. PONIT (1) brings a new phase of the advance. This new line, of course, runs from 1-2, with price getting support from the support line.
How to Determine the Significance of a Trendline Trading Strategy
- The number of times the trendline has been touched or approached. The larger the number, the greater the significance. A trendline that has been successfully tested five times is obviously more significant than one that has only been touched three times.
- Time factor, a trendline that has been in effect for nine months, is of more importance than one that has been in effect for nine weeks or nine days.
- Angel of ascent and descent, a very sharp trend is difficult to maintain, and it’s liable to be broken. The steep trend is not more important than a more gradual one. A large angle on a lower trendline in an uptrend means that the lows are rising significantly fast and that the momentum is high.
THE TREND CHANNEL
Occasionally, the momentum produced by the forces of demand and supply will become so plainly marked as to develop a well-defined zone of activity; that is, the alternating buying and selling waves form a price path or channel whose upper and lower limits are easily identified by a series of tops and bottoms confined within parallel, or nearly parallel, lines.
The drawing of the channel line is very simple. In an uptrend, first, draw the support or demand line along with the lows (A-C). Then, draw a line from the first prominent peak (point B) parallel to the support or demand trend line. Both lines move up to the right, forming a channel. If the next rally reaches and backs off from the channel line (at point D), then a channel may exist. If prices drop back to the original trendline (at point E), then a channel probably does exist. The same holds true for a downtrend, but of course, in the opposite direction.
In the uptrend, the supply line acts as overbought, and the price will be reversed from the supply line. The support line acts as an oversold.
Use of Trendline in Trading:
The use of trend lines is frequently helpful in judging the points at which you may expect the price:-
- To be supported on reactions;
- To meet resistance on rallies and
- Overbought and oversold condition sowing in channel
- To approach a critical position in its travel from one level to another. Trend line l also helps you to foresee the possibilities of an impending change of trend before it actually takes place.
Violating a trend line often (but by no means always) may signify that the force of demand or supply that was formerly in effect is now becoming exhausted. This may either mean that the price movement is changing its rate of progress, or it may mean that the trend is definitely in danger of being reversed.
Trendline Trading Strategy
It is bad practice to enter a stock simply because it has penetrated an established. Trendline or broken out of an extended congestion area. The significant thing is HOW the line is broken, the conditions under which the change of stride occurs.
The quality of the buying or the selling at and around the point of penetration determines whether the violation of an established trendline may be regarded as evidence of a further price movement in the direction of the breakthrough or whether it means the only temporary change of false breakout. For a breakout, the price must close above or below the trendline.
An opposite trade to be taken on the retest of the trendline
Trendline Trading Strategy Summary:
Trendline trading strategy involves using straight lines drawn on the price chart that connect a series of highs or lows. The resulting line acts as a level of support or resistance for the price. Traders use these lines to make educated guesses about how the price will behave. Here’s how to develop a trendline trading strategy:
1. Drawing Trendlines:
- Uptrend Line (Support): Connect at least two higher lows to draw an uptrend line. The more points the line touches, the stronger it is considered.
- Downtrend Line (Resistance): Connect at least two lower highs to draw a downtrend line. Similar to the uptrend line, the validity of the downtrend line increases with the number of touches.
2. Identifying the Trend:
- Bullish Trend: If the price is making higher highs and higher lows and is above the uptrend line, the market is considered an uptrend.
- Bearish Trend: Conversely, if the price is making lower highs and lower lows below the downtrend line, the market is in a downtrend.
3. Trading with Trendlines:
- Buying on Support: In an uptrend, traders look for buying opportunities when the price touches or approaches the uptrend line and shows signs of a bounce.
- Selling on Resistance: In a downtrend, traders may look for selling or shorting opportunities when the price touches or approaches the downtrend line and shows signs of rejection.
4. Breakout and Breakdown Trading:
- Breakout: A price that breaks above a downtrend line may indicate a trend reversal from bearish to bullish. Traders might take a long position after such a breakout, often waiting for a retest of the trendline.
- Breakdown: Conversely, a breakdown below an uptrend line might signal a change from a bullish trend to a bearish one. Traders could enter a short position following such an event.
5. Entry and Exit Points:
- Entry: Enter trades when the price action confirms the role of the trendline (support in uptrends or resistance in downtrends) through patterns like pin bars, engulfing candles or when indicators such as moving averages or oscillators confirm the trendline’s validity.
- Exit: Set stop-losses just below the trendline in an uptrend or above the trendline in a downtrend. Take-profit levels can be determined based on other technical analysis tools, such as previous resistance or support levels, or using a risk-reward ratio.
6. Combining with Other Indicators:
- Volume: A breakout or breakdown should ideally be accompanied by increased volume for added confirmation.
- Oscillators: Indicators like the Relative Strength Index (RSI) or Stochastic can help confirm whether the price is in overbought or oversold territory when it reaches the trendline.
Tips for Trendline Trading Strategy:
- Validation: The more times a trendline is touched without being broken, the more valid and important it becomes.
- Slope: The slope of the trendline can also give clues about the trend’s strength. A steep trendline may be less sustainable than a moderate one.
- False Breakouts: Be aware of false breakouts; some traders wait for the price to close above/below the trendline before entering a trade.
- Timeframes: Use multiple timeframes to find the most significant trendlines; what is visible on a daily chart may be more impactful than what you see on a 15-minute chart.
- Patience: Wait for clear signals before entering a trade based on a trendline. Patience can help avoid jumping in on false signals.
Limitations of Trendline Trading Strategy:
- Subjectivity: Drawing trendlines can be subjective; different traders might draw different trendlines on the same chart.
- Not Infallible: Trendlines are tools, not rules. Prices can and do break trendlines, and strategies should not rely solely on them.
Incorporate trendlines into a comprehensive trading strategy that includes proper risk management and considers overall market conditions. As with any trading strategy, it’s essential to practice in a simulated environment before applying these concepts to live trading.
In the next article, I will discuss the WRB Trading Strategy in detail. Here, in this article, I try to explain the Trendline Trading Strategy in detail. I hope you enjoy this Trendline Trading Strategy article. Please join my Telegram Channel and YouTube Channel as well as my Facebook Group to learn more and clear your doubts.
About the Author: Pranaya Rout
Pranaya Rout has published more than 3,000 articles in his 11-year career. Pranaya Rout has very good experience with Microsoft Technologies, Including C#, VB, ASP.NET MVC, ASP.NET Web API, EF, EF Core, ADO.NET, LINQ, SQL Server, MYSQL, Oracle, ASP.NET Core, Cloud Computing, Microservices, Design Patterns and still learning new technologies.