Trendlines are one of my favorite trading tools because they allow us to explore market psychology and trends in many different ways and they are also universally applicable across timeframes, markets and market conditions.
In this article, I will give you a complete introduction to trendlines and how to use them in your trading.
How to draw and use trendlines 101
Generally speaking, it is advisable to wait for three confirmed points of contact before you start putting further attention to a trendline. Most traders make the mistake and connect the first two highs or lows and then get overly excited once the price gets there again. However, a trendline is only confirmed if you can get three points of contact because you can always connect any two random points on your charts. But when three points of contact are lining up, it is no coincidence anymore.
The next question that always comes up is whether you should use the candlestick-wicks or the candle-bodies to draw the trendlines!? The answer is confluence.
Whenever you get the best and the most contact points and confluence around your trendline, that’s how you draw it. There are no fixed rules about whether wicks or bodies are better. Just look for a trendline that gives you the most confirmation without beeing violated too much.
At the same time, consistency is very important as well. You should define for yourself how you draw trendlines and then always stick to that approach to avoid noise.
Below you see a screenshot with 2 possible trendlines and multiple touches each. After the third touch, the trendlines have been confirmed and you can see how I use both the wicks and the bodies to get the trendline in.
Upper and lower trendlines
The next question that comes up is whether you draw trendlines connecting the lows or the highs. The answer is very straight forward:
During a downtrend, I use the highs and during an uptrend, I use the lows to draw a trendline. This has two benefits: You can use the touches to get into trend-following trades and when the trendline breaks we can use that to trade reversals.
The slope and angles: trend strength
The slope – or the angle – of trendlines immediately tells you how strong a trend is.
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 screenshot below shows an uptrend with steadily increasing angles of trendlines. The trend is gaining momentum and the trendlines visualize it perfectly.
Some people will call this the bump and thrust pattern when you see that a trend is suddenly gaining even more strength and then the trend becomes unsustainable at one point.
The next screenshot shows the opposite: a downtrend with multiple trendlines that show decreasing angles. Obviously, the trend is losing momentum.
Reading trend structure
The screenshot below shows a primary downtrend as indicated by the red arrow.
During the primary trend, one can start looking for weak consolidation phases and apply trendlines to those price movements. The low angle of the trendlines indicates that the consolidation does not have a high chance of turning into a real bullish reversal. The sellers still keep pushing the price very close to the bottom of the move, the higher lows are very shallow and the buyers cannot take over the price action. One then just has to wait until the trendline is broken and the downtrend is resumed.
Of course, you won’t always be able to draw a trendline, but if you can find one, they can be high probability trade setups.
Trendline patterns: Wedge
There are a few patterns in technical analysis that are based on the principles of trendlines. The Wedge is a very popular one and we can apply our knowledge here nicely.
In the scenario below, the lower trendline indicates that the price is falling very slowly as the angle of the lower trendline is very shallow. This already shows that the sellers are not as strong in this market anymore. In the end, before the strong reversal, the market makes one final push which ends as a fake breakout. This pattern is also referred to as a Bull / Bear trap.
The two trendlines are also converging which shows that the market is in a consolidation phase. The trend waves are becoming smaller and smaller and the whole market is slowing down. During a wedge pattern, it is best to stand aside and to not take any new positions. Once the trendline is broken to the upside, the wedge gets triggered and the bullish move, that was already indicated, can start.