Trends and Trendlines

Trends move in three different directions – up, down and sideways. An uptrend is defined as having higher lows and highs. Similarly, a downtrend is defined by having lower highs and lows. When a trend moves sideways the price is said to be in a range.

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Trendlines

Trend Lines are created by connecting the tops of support levels or the lows of resistance levels. The highs and lows are used to mark support and resistance as shown in the Uptrend and Downtrend examples above.

By connecting the prior tops and extending the line, traders can get an idea of where the resistance is likely to be in the future. Future support levels can be estimated by connecting the prior lows.

As long as the price continues to obey these levels, we can continue to trade inside the range. This is under the condition that we remain aware of the other support and resistance levels that may be found inside of the range. The trend lines themselves become additional support and resistance levels.

When the price breaks past the support or resistance levels defined by a trend line, we look to make a trade in the same direction as the breakout. However, as 81% of all breakouts are usually false breakouts, there is a need for caution and an additional step is required to confirm them.

Avoiding False Breakouts: the Re-test


When the price breaks below a trend line that has been acting as support, it will typically come back up to test that same level again – but this time as resistance. The best short entries are not taken on the initial break, but rather on the second move downwards, following this “re-test” of the level in question.

A successful re-test is defined as a candle body closing outside that level. In the example below, we can see that price broke below the support, failed the first re-test as resistance, and then continued to successfully pass on the second attempt. This pattern is also known as a "good-bye kiss".

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The same scenario can be reversed when the price breaks above a trend line that previously acted as resistance. In this case, we look for that same trend line to be re-tested as support prior to taking a long position.

The Trendline Break System


By using trend lines you can form one of the simplest trading systems. In an uptrend, we connect the bottoms of the candle bodies. If we are long from before, we look to exit the trade as soon as the price breaks to the downside. If at the moment, we are absent from a trade, then we may think about taking a short position at this point.

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Similarly, in a downtrend, we connect the tops of the candle bodies. If we are short from before, we look to exit our trade as soon as the price breaks to the upside. If we are not yet in a trade, we may consider taking a long position at this point.

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Next article: Indicators, Part I The Trend Followers

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