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Browse Topics:    Trading Strategies    Research & Analyze    

Trend Lines: How Traders Use Them

Examine a chart tool that helps detect the direction and magnitude of a trend.

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A trend line is simply a straight line drawn on a price chart connecting two or more high or low prices established over a given period of time. Many traders find these lines to be helpful in identifying important price trends and trend reversals.

Bullish (or Rising) Trend Lines
A "bullish" trend line is used when prices have been increasing. An "uptrend" is broadly defined as a series of higher highs and higher lows. A bullish (rising) trend line is drawn by connecting two or more recent lows in price, and extending the line into the future, up and to the right.

Trend Lines: How Traders Use Them
Figure 1: Example of an uptrend line

Each time the price touches or nears the bullish trend line and stays above it, it is considered to be a confirmation of the uptrend. The more times that price comes down and touches or nears a bullish trend line, without breaking below it, the stronger and more significant the uptrend is considered to be. In conjunction with other supporting indicators, a bounce off of a trend line can be used to find potential entry and exit points for a trade.

Eventually price action will move below a bullish trend line. This action is typically referred to as a "down side trend line break". However, an initial trend line break does not necessarily mean that the uptrend is over. Some traders will wait to see how the security behaves after the trend line break before taking action.

One very common phenomenon that often occurs after an initial trend line break is what is often referred to as a "retest" of the trend line. This action generally involves price breaking below the trend line and then rallying back up to touch the rising trend line from below.

Trend Lines: How Traders Use Them
Figure 2: Example of a retest of a broken bullish trend line.

In cases where price moves back above the original trend line, the break below the original trend line is considered to be invalidated and a trader will once again assume that the primary trend is bullish.

On the other hand, if price does retest the original bullish trend line but fails to break back through to the upside, or the longer a security fails to retest the previous bullish trend line, then the more likely it is that the original bullish trend has in fact ended. From here the price of the security may start trading sideways, or it may reverse to the downside and in the process begin a new primary downtrend.

Bearish or Downward Trend Lines
A “bearish” trend line is used when prices have been decreasing. A “downtrend” is broadly defined as a series of lower highs and lower lows. A bearish (or declining) trend line is drawn by connecting two or more recent highs in price, and extending the line into the future, down and to the right.

Trend Lines: How Traders Use Them
Figure 3: Example of a downtrend line

Each time the price touches a bearish trend line and stays below it, it is considered to be a confirmation of the downtrend. The more times that price comes up and touches or nears a bearish trend line, without breaking above it, the stronger the downtrend is considered to be. In conjunction with other supporting indicators, a bounce off of a trend line can be used to find potential entry and exit points for a trade.

Eventually price action will move above a bearish trend line. This action is typically referred to as an “upside trend line break.” However, an initial trend line break does not necessarily mean that the downtrend is over. Some traders will wait to see how the security behaves after the trend line break before taking action.

Trend Lines: How Traders Use Them
Figure 4: Example of a retest of a broken bearish trend line.

Just as with a downside break of a bullish trend line, an upside break of a bearish trend line will sometimes be followed by a “retest.” In this case, the process involves price breaking above the bearish trend line and then declining back down to touch the falling trend line from above. In cases where price moves back below the original trend line, the break above the original trend line is considered to be invalidated and a trader will once again assume that the primary trend is bearish.

On the other hand, if price does retest the original bearish trend line but fails to break through, or the longer a security fails to retest the previous bearish trend line, then the more likely it is that the original bearish trend has in fact ended. From here the price of the security may start trading sideways or it may reverse to the upside and in the process being a new primary uptrend.
 
Many traders will also consider looking at other indicators, such as volume, to get a fuller picture when any bullish or bearish trend line is broken. For instance, a trend line break that is accompanied by larger than normal trading volume is generally considered to be of greater significance that a break accompanied by light trading volume.

Sideways or Horizontal Trend Lines
The price of a stock or asset may move in a sideways channel for a period of time. When this occurs, the asset is said to be in a “trading range.” The upper and lower boundary of the trading range can often be identified by drawing sideways lines across a price chart. Once a clear boundary has been established many traders will watch closely to see what happens when price once again approaches the upper or lower boundary. Very often a breakout outside of an established trading range can give an early signal that a meaningful new trend is emerging.

Trend Lines: How Traders Use Them
Figure 4: Example of a trading range.

Time Frames
When discussing trends and trend lines, it is also important to discuss timeframes. There can be different trends from one timeframe to another. For example, it may be possible to draw a bullish trend line when looking at the previous year of trading and a bearish trend line when looking at just the previous three months of trading. Likewise, there may be a bullish trend on a daily chart and a bearish trend on a weekly chart. When the same trend appears across multiple timeframes, the trend is generally considered to be stronger. When trends differ from one timeframe to the next, the trend is generally considered to be weaker.

That being said, conflicting trends can occasionally highlight good trading opportunities. Consider the original example of a bullish trend line drawn using a year of data and a bearish trend line drawn using three months of data. As long as the longer-term bullish trend line remains intact, an upside break of the bearish shorter-term trend line may signal a useful buying opportunity.

Conclusion
They say, "The trend is your friend…until the end." Trend lines can help to clarify both the trend and the end of the trend. In addition, in the case of a breakout from a trading range, trend lines can be helpful in offering an early clue that a new trend may be emerging.

Trend lines are useful tools, simple to draw and see on a chart, but are best used as one part of a larger “weight of evidence” in assessing the strength of a trend, and making entry and exit decisions.

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