Trendlines: A Price Roadmap

- What?

    A trendline is a common term given to an extended line that has been drawn by connecting two points on a chart. The main idea of the trendline is to provide a key area of support or resistance when it is touched for the third time later on the chart. There is nothing tricky about trendlines, and the concept is quite simple.

- Why?

    Drawn correctly, trendlines are extremely powerful. One trendline provides an objective view towards the market, leaving all "noise" aside. By saying objective, I mean that the trendline becomes an undeniable, immovable area of expected support or resistance, depending on the situation. While there may be subjectivity in WHERE trendlines are drawn, all subjectivity disappears once the line is drawn. From that point on, that line projected into the future is at one very clear area when price chooses to test it next.

    TL's allow the trader to easily see how multiple timeframes mingle and fit together. The idea of fractal movements is everywhere in trading, from fibonacci ratios and Elliot Wave patterns to every type of indicator, but a simple trendline can provide insight on where the markets may head next. For example, drawing a trendline on a 15 minute chart gives an expected view of the market for the future. At the same time, drawing trendlines on a smaller chart (5 minute, for example) will provide a more detailed view of the market and often gives more distinct ideas on HOW price might get to where the 15 minute chart trendline suggests.

    Most importantly, trendlines work because they are based on historical price and time, which happen to be the footprints of all trades. Since trendlines are drawn with respect to only these two variables, a pure projection of price action can be suggested for the future. Past support can provide a great implication of future support through the use of a trendline, and the same goes for past resistance. It is for these several reasons that a basic idea of a trendline can be such a useful tool in the markets.

- How?

    It is very simple to draw a trendline, no matter how advanced you are in your trading carreer. It is a two step process that begins with identifying two "swings" in the price action. (assuming you are drawing trendlines on price) Many questions are asked on what defines a SWING, and there really is no concrete answer. Instead, experience is the only true teacher for this. Generally, if a swing is not clear on the timeframe being studied, it is move visible by dropping down to a lower time frame. Conversely, if the swings are spread out to the point that they look odd on the chart, move up a time frame and it often fits together better. Remember, cycles within cycles are all over in the market and there is no such thing as a "wrong" trendline. After diligent practice and application, identifying useful swings will become second nature.

    Once the swings are identified, simply connect the two with a line, starting with the leftmost swing. This will give you a straight line that can then be extended right into the future. This is a basic trendline, and clearly shows the first two touches. (the swings you connected) The analysis and usefulness then comes on the third test which will be the NEXT time this trendline is touched.

- Trendlines to Profits

Trendlines provide two extremely basic, yet very important keys that lead to consistent profits: Support and Resistance. It sounds too basic...too simple...too elementary, but trading with trendlines comes down to buying support and selling resistance. There are no special formulas, and a magic wand is not needed. Buying support and selling resistance will allow a trader to be extremely profitable. The key, then, is determining HOW to trade the support or resistance areas that our trendlines so kindly provide for us.

    As stated before, trendlines are drawn to help predict the market movements that may occur in the future. There is only one rule that must be adhered to when using trendlines: expect price to bounce off a trendline whenever it is touched, until it no longer becomes "valid" . This sounds too simple because it is. A trendline below the current price is suggesting a level of support. The idea is to buy this support until  the trendline is violated. Some trendlines offer no opportunity while others offer six, seven, eight, nine or ten bounces that can be profited from. Either way, buying support and selling resistance will keep you out of trouble if you keep losses small.

    How do you keep losses small? That's simple...if you are buying the support of a trendline and the trendline is being violated, your expectations of the market were not correct. Get out of the trade, you were wrong. There should not be any personal bitterness or any other emotions that come from this result, and in fact it's best to expect this to happen on a regular basis because it will. Stick with the plan, buy the support until it is no longer support. Once this happens, what was support then becomes resistance. If price action breaks a trendline, that trendline is still valid . Often times it provides an entry for a trade in the opposite direction.

    There are two things to remember when playing with trendines: 1. Buy Support / Sell Resistance and 2. Broken support becomes resistance / Broken resistance becomes support. Keeping these two things in mind will bring consistent profits after quality practice.

- Tips and Tricks

1. Generally, the more obvious trendlines (which can only be drawn with the more obvious swings) provide the stronger support/resistance. This is only natural because the more obvious these levels are, the more traders will be looking at the same thing, which is what drives the market.

2. Multiple trendlines converging near the same area show an even stronger area of support/resistance. This is often easiest to see when using multiple time frame analysis. The more lines at a specific price level, the more key that level is.

3. The more times price bounces off a designated trendline, the stronger the support/resistance becomes.

4. If finding appropriate swings to base trendlines on seems to be a problem, it may be necessary to move up a time frame to get a larger picture of what the market is doing.

- Suggested Exercise

1. Using historical charts, draw clear trendlines on 10 sets of charts and study how price reacts off of them. Once completed, it may be wise to put these in a notebook to study or hang them on a wall. See the charts below for an example of this exercise.

2. Once the above has been completed and an understanding of trendlines is accomplished, draw clear trendlines on 10 sets of charts in REAL TIME, or by using a demo trading platform. The idea here is to learn to spot the swings in real time, as they are forming.

(interactive video lesson coming soon...)

This chart is from 2/5/2004:

This chart is from 2/4/2004:

This chart is from 2/3/2004:

This chart is from 2/2/2004: