How To Use Trendlines Effectively For Day Trading

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How to Use Trendlines in Your Trading

A key part of delving into technical analysis and trading off of charts, trendlines make an excellent tool for traders—if they’re used correctly. Used improperly though, they become ineffective and even counterproductive.

This might result in the false belief that prices have made a reversal or that a trend has strength when price action suggests it doesn’t. The following tips can help you effectively use trendlines as part of your trading strategy.

The Basics of the Tool

Trendlines highlight a trend or range (sideways movement). A trendline connects a swing low to a swing high, from the lowest point of the downward movement to the highest point in the upward movement. When the price rises, the trend line rises accordingly.

Connecting these lows with a line results in an ascending trendline, showing you that the prices are trending upwards. A trendline can also be drawn along the individual swing highs. This shows the angle of ascent, the strength of the price move, and the relative strength of the trend.

When the price falls, the swing highs fall. Connecting these highs with a line results in a descending trendline, illustrating the downward trend. A trendline can also be drawn along the swing lows. This shows the angle of descent​ and the strength of the downward price movement.

Multiple Trendlines

Typically, you would have more than just one trendline in play. At any given moment you could draw many trendlines, all showing the price movement over various periods of time.

Trendlines at very steep angles typically have a short life, since prices cannot sustain a near-vertical rise or fall for long.

That said, drawing trendlines whenever possible can aid new traders in spotting the overall trend, while also highlighting small trends and corrections within that overall trend.

During an uptrend, buying or going long opportunities may occur when a short-term downtrend meets the overall ascending trendline. During a downtrend, selling or shorting opportunities may occur when a short-term uptrend meets the overall descending trendline.

Adjusting Trendlines

Once drawn, trendlines often need to be adjusted. Prices don’t usually move in a uniform fashion, and since trendlines account for both time and price, they move along the price and time axis.

This means that any acceleration or deceleration of the trend requires adjustments to the trendline. Trendlines work as a tool, and can’t be relied on solely. To decide whether a trendline should be adjusted, or whether it has been definitely broken, consider how the price moves within a trend.

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During an uptrend, the price makes higher highs and higher lows. As long as that keeps occurring, if the price moves below the trendline it doesn’t necessarily mean the trend has ended, the line may just need to be adjusted.

During a downtrend, the price makes lower lows and lower highs. As long as that happens, if the price moves above the descending trendline it doesn’t necessarily mean the trend has ended, the trendline might simply need to be adjusted.

Trendlines as a Guide

The need for constant adjusting makes a trendline imprecise for use as a trade signal. Also, consider that a trendline drawn at a slightly different angle can make a big difference in what price that trendline intersects with.

Therefore, while you can use trendlines as a guide, use more precise criteria for entering a trade, such as a move back in the trending direction, an engulfing pattern (where the next bar is larger than the previous one, engulfing it), or an indicator that adjusts more precisely and quickly to changes in volatility.

If you use trendlines as just a guide, then you don’t need to worry about drawing trendlines along the exact highs or lows. Draw “trendlines of best fit.” The best fit trendlines still provide you with a visual trend and alert you to potential trade areas.

In some cases drawing trendlines along extreme highs and lows works, but when it doesn’t, draw trendlines of best fit. Since the trendline isn’t being used as a trade signal, it still provides you with relevant information about the trend, without the need to constantly readjust it.

Final Word on Trendlines

Trendlines are a great tool, showcasing short-term trends within the overall trend. Pay attention to price action and always consider it when using trendlines. If the price makes lower lows and lower highs, it’s still a downtrend even if the price moves above a descending trendline.

If the price makes higher highs and higher lows, the price still has an uptrend even if it moves below the trendline.

A trendline needs to be adjusted often, especially when day trading. Use “trendlines of best fit” to avoid constantly adjusting. The trendline of best fit still shows the trend and when the trend may be reversing.

Use trendlines to alert you of potential trade opportunities, and use price action signals (taking action on trades simply by the price) to get in.

Beginners Trading Concepts: Using Trendlines Effectively

Trendlines are an analysis method that every beginning trader should take the time to learn about and understand. Using price history to analyze the market is a powerful way to trade, as price is the only true indicator of market direction, upon which profits are made or losses realized. Trendlines are one tool used to analyze markets; they help you determine when trends are underway, when price is stagnant–and not worth trading–and when the price direction may reverse. Trendlines are used by traders of all levels, and even basic trendline concepts can be transformed into excellent trading strategies for those who take the time to study them and their applications.

Price rarely moves in one direction for long, rather it is constantly moving both up and down. Trends in price develop when buying is more powerful than selling, or vice versa. An uptrend occurs when the price reaches new highs as it rises, and when it falls manages to stay above former price lows. A downtrend occurs when the prices reaches new price lows as it declines, and stays below former highs when it rises. Figure 1 shows this concept visually for an uptrend–both the price swing lows and highs are higher than the former swing lows and highs.

Figure 1. EUR/USD Daily Chart

Source: Oanda – MetaTrader

The up and down movement of an assets price creates trends, such as the uptrend shown in figure 1. To make it easier to see an uptrend or downtrend, a drawing tools–available on nearly every trading and charting platform–can be used to “highlight” the trend. By drawing a line to mark price trends, you can also clearly see multiple trends which may be occurring on different time frames. This is very useful when switching between a daily chart and an hourly chart for example, as you will be able to see the trends which are in effect on both timeframes, providing additional insight for you to consider before trading.

Draw a trendline for an uptrend by selecting the “trendline” drawing tool in your trading/charting platform. In the case of uptrend, start drawing the trendline where the trend begins (a low point), and then extend the line so it runs just below the price lows that follow. For a downtrend, again start at the beginning (a high point) and extend the line down along the price highs that follow, as shown in figure 2.

Figure 2. EUR/USD Daily Chart with Trendlines

Source: Oanda – MetaTrader

Adjustments Are Often Needed

The left side of figure 2 shows an uptrend, although two different trendlines have been drawn to show it. When trading in real-time trendlines often need to be redrawn or adjusted. In figure 2 the price drops below the first trendline (shorter green line), but is actually still in an uptrend since the price low is higher than the former price low. Therefore, once this occurs and the price starts moving higher again, the trendline can be re-drawn (longer green line) to reflect the new information and accommodate the new price low.

Such adjustments and redrawing of trendlines occur often. Price doesn’t move in perfect harmony, where each up and down movement is exactly like the last. Trendlines only provide a rough estimate of the trajectory of a trend.

Trendlines are typically used to highlight trends and signal potential price reversals. When a trendline is broken–price moves through it instead of respecting it– the trend may be reversing. Although, since we know trendlines often need to be redrawn or adjusted, the breaking of a trendline is not usually a buy or sell signal in and of itself, although it can be. Toward the right side of figure 2, the uptrend is broken by downward price movement. A downward trendline can then be drawn (red line), indicating the price has shifted into a downtrend for the time being. The price also created a lower low than the prior swing low, providing further evidence that a downtrend is underway.

A trendline is also used to indicate potential price areas of support or resistance. When price is in an uptrend, use the trendline to gauge when a correction will stop declining (support) and the price will begin to move higher again. In a downtrend, use the trendline to gauge when the price may stop rising (resistance) on a correction, and begin declining again. The price “bouncing” off a trendline in this manner can be used as the basis for a strategy. It’s unlikely though that the price will stop exactly at the trendline. Use the trendline simply as a guide; the price may stop just short of the trendline or just beyond it, therefore some flexibility is needed when using trendlines.

Figure 3 shows this strategy in motion. As the price moves up toward a descending trendline, and then begins to decline again–effectively “bouncing” off the trendline–a short trade, or option put trade is made.

Figure 3. EURUSD Daily Chart with Trade Signals

Source: Oanda – MetaTrader

Trendlines, like all other forms of analysis, are not perfect. Often trendlines will need to be redrawn which means that if you used them for providing trade signals, some losing trades will occur. Trendlines do provide a good context for price movement though. A trendline can help estimate the future price trajectory, and also warn you when a trend may be reversing. Remember that trends occur on multiple time-frames. For example, the price may be moving in an overall downtrend on the daily chart, but an uptrend on the 15-minute chart. By looking at both longer-term and shorter-term trends, you can gain greater insight into the likely future price movements of the asset. This can result in filtering out some “bad” trades as well as seeing potentially profitable trades you may not have seen by looking at only one timeframe or trendline.

How to Use Trendlines for Trading – Dispelling the Myths

Trendlines are a useful tool for visually highlighting a trend, and potentially being part of a trading strategy. There are a lot of myths and inaccurate information about trendlines though. Learning how to use trendlines effectively–if you are going to use them–is crucial so you don’t fall into several common traps.

Trendlines are a technical analysis tool used to define and project price trends in major markets such as stocks, forex, and futures. Trendlines have the potential to alert us when a pullback (move against the dominant trend) is over and the trend is resuming, or when a trend is accelerating or reversing (for more on trends, see Impulse and Corrective Waves). But price is the ultimate indicator. Therefore, price action (how the price itself is moving) must always be considered when using trendlines.

Here’s how to use trendlines for trading.

Whether you use trendlines or indicators, price action is what ultimately determines how much money we make. Learning about price action and how trends move is never a bad idea. Once we understand the basic concepts of how prices move, then trendlines become a more effective tool in helping us analyze that price action.

Prices constantly move up and down, even within a trend. While most traders know this, they have a hard time applying that knowledge in real-time. Traders often wait too long before entering, buying near the top of a price wave, or they panic as the pullback begins and end up getting out when the pullback is ending. Trendlines, discussed later, can help in this regards.

Figure 1 shows a basic uptrend. The uptrend begins by making a higher price high and then a higher price low (relative to the price waves that occurred prior). The price continues to make higher swing highs and higher swing lows. “Swings” refer to each major move up or down.

During an uptrend, we see this progress of higher swing highs and higher swing lows. When the price creates a lower swing high or a lower swing low, the trend is potentially in jeopardy. Once the price makes both a lower swing high and lower swing low (they don’t need to be in that order) then a downtrend could be underway–or it at least presents the possibility that we could see more downside. Trends can last for a long time and many waves, or they may only last a few price waves.

Figure 1. Higher Highs and Higher Lows – An Uptrend

During a downtrend, we see lower swing highs and lower swing highs. When the price creates a higher swing high or a higher swing low, the downtrend may be reversing. Once the price makes both a higher swing high and higher swing low (they don’t need to be in that order) it becomes more likely that the price could move further to the upside overall.

Pullbacks within larger trends, such as a pullback on a weekly chart, can often appear as trends on shorter time frames such as the daily or hourly chart (in figure 1, a pullback is the price move between the swing high and swing low). Even on the daily chart above, there are small waves within the larger labeled waves which haven’t been accounted for, which in real-time could cause some confusion. Reading price action is subjective; the basic concepts stay the same but how each person views the trend may vary slightly based on what they see and the time frame they are trading on.

Understanding the basic concepts of price action is crucial, because it applies to every trend we trade. If trading with a trend we want to see this type of movement–higher highs and higher lows for an uptrend, and lower highs and lower lows for a downtrend.

When a trend is no longer exhibiting these characteristics caution is warranted. It doesn’t necessarily mean the trend is reversing, but it does indicate a deeper pullback is occurring, or a reversal is potentially underway. Another key ingredient in reading price action is analyzing the velocity and magnitude of price waves, then comparing the velocity and magnitude of each price wave to the price waves around it.

How Trendlines are Useful for Trading

Price charts produce “noise.” Noise is the small random movements that can make it hard to spot the trend. Therefore, many traders prefer to simplify their charts. The uptrend in figure 1 is simplified by using a trendline, which highlights the trend and quickly shows the overall price direction.

This is very useful when looking at multiple time frames or when there are conflicting price action signals. By looking at the direction of the trendline traders can cut through the BS and see in which direction they should be trading.

Anytime there are two highs or two lows a trendline can be drawn. The trendline is drawn by connecting one high to the next, or one low to the next low. When starting out, draw as many trendlines as possible in all directions. This helps differentiate pullbacks and short-term trends from longer-term trends.

We also often have biases when we look at a price chart, which may not always be correct. By forcing ourselves to draw all relevant trendlines, especially at the far right of the chart (most recent price action), we may realize our initial bias wasn’t correct at all. Being able to see trends and pullbacks of different sizes will aid you in your overall analysis and chart reading abilities. This skill can then be applied to trading strategies based on price action and trendlines (see How to Day Trade Forex in Two Hours or Less).

How to Draw Trendlines on Your Chart

Trading software and charting platforms vary, but all of them should have a trendline or line tool. Select the tool. For an uptrend, connect the line from the low of one wave to the low of the next, and then extend it out to the right to provide a projection of where the next wave lows could possibly occur.

For a downtrend, connect the high of one price wave to the high of the next price wave and then extend it out to the right. The lines provide a projection for where future wave highs may occur.

If you are just starting out, TradingView.com is a free site with live real-time price charts, and great technical analysis tools.

Figure 2. Trendlines Drawn On a Chart

How to Use Trendlines for Trading – Adjustments Are Required

Trendlines are not only based on price, but also have a time element. This creates a great myth. Traders will often say that because a trendline is broken the trend is over. That is not true. The price could break through a trendline just because it look longer for a wave to complete. This is very common when the price is moving sharply higher or lower. For example, if the price is making rapid higher highs and higher lows, the trendline will be angled steeply upwards. That type of momentum can’t last forever, and eventually the trend will slow down. The price will break the trendline, but it doesn’t mean the trend is over, just that it has slowed down (as we should expect!). This is why we always consider price action in conjunction with trendlines.

Figure 3 shows an example of this. The price breaks the trendline but the price is still making overall higher highs and higher lows. It was crucial to monitor the price action, and not just the trendline, in order to see this was still an uptrend. The trendline was still effective in point a number of potential trade areas earlier in the trend (will be discussed a bit later).

Figure 3. Monitor BOTH Price Action and Trendlines

Trendlines will often need to be redrawn. They are not a perfect trading tool that tells you exactly where a trend will reverse. You will draw a trendline connecting highs or lows, only to see that the next price wave doesn’t match up with the trendline exactly. You now must decide if you want to redraw your trendline to accommodate these misalignments.

For a long-term trend, you may need to redraw the trendline multiple times. Alternatively, you may keep each of the trendlines you draw on your chart, showing the various stages the trend (near vertical, slow ascent, etc) has been through. This will remind you that conditions are always changing so don’t rely too heavily on the trendline… use price action analysis as well.

In figure 4, the price action isn’t very pretty, but trendlines help us see when the price is trending, when it is pulling back, and when it’s moving in a choppy fashion (no real trends present).

Ideally, if using trendlines for trading purposes you want to be trading assets with strong trending tendencies. A chart/asset like this one you would avoid since trading signals are harder to pick out. That said, for analytical purposes, trendlines help us see what is happening so we can strategize for the future (sometimes the best strategy is to not trade when conditions don’t warrant it).

Figure 4. Multiple Trendlines/Redrawing Trendlines, with Commentary

How I Use Trendlines in Trading

Instead of connecting exact highs to exact highs, or exact lows to exact lows, I draw trendlines of “best fit.” Trendlines only show us an “area” of potential interest, not an exact price level of interest. While textbooks show examples of beautiful trendlines where the price seems to magically bounce off them at exact levels, that isn’t usually the case in the real world.

A trendline of best fit connects as many highs together, or as many lows together, as possible. It is okay if the trendlines move through price bars (instead of running along exact highs and lows). The trendline still shows the overall movement of price, the trend direction, and provides areas of interest for potential trade signals (discussed next). The trendline also won’t need to be redrawn as often.

Figure 5. Trendline of “Best Fit”

How to Use Trendlines for Trading – Trade Signals

There are multiple strategies which could combine trendlines and price action. Here is one such simplified strategy:

—When the trend is up, if a pullback stays above the prior swing low and moves into the vicinity of the rising trendline, enter long (buy) when the price moves back to the upside (trending direction). Use a trade trigger to signal the actual entry, as discussed below.

—When the trend is down, if a pullback stays below the prior swing high and moves into the vicinity of the falling trendline, enter short when the price moves back to the downside (trending direction). Use a trade trigger to signal the actual entry, as discussed below.

Trendlines often need to be redrawn, therefore the price touching or moving through a trendline is not a trade signal on its own. We must also look at overall price movement. If the price movement warrants a trade it must produce a “trade trigger.”

A trade trigger is a precise event which tells us right now is the time to enter. The Engulfing Candle Strategy and the consolidation breakouts discussed in How to Day Trade Stocks in Two Hours or Less reveal entry techniques (trade triggers) and provide useful information for reading price action and using trendlines. These techniques are best used in conjunction with “trendlines of best fit.”

Trendlines help us keep focused and trading in the direction of the overall trend. The trendline provides an area where we should be on high alert for trading opportunities. This is especially true when using “lines of best fit” because multiple pullbacks have reversed near the trendline.

Fibonacci Retracements are also used in conjunction with price analysis and trendlines to find areas the price is likely to pull back to.

In the case of a downtrend, stop loss orders are placed just above the high of the current pullback. In an uptrend, the stop loss is placed just below the low of the current pullback. We can use the high and the low of the current pullback because we are entering once the price starts moving back in the trending direction.

The above is a quick guide to general trendline use. For additional reading, see How to Spot Trading Opportunities and the Day Trade Trending Strategy.

Drawing Trend Channels

Connect highs to highs and lows to lows during a downtrend or uptrend and you may end up with a trend channel. As discussed above, a rising trendline (connecting the lows) during an uptrend can provide area of interest for seeking long positions. The line which connects the highs during an uptrend is also relevant. It lets you know where the price has had a tendency to pull back from, and therefore can aid you in picking a profitable exit for your trade.

When drawing trend channels, trendlines of best fit are recommended.

Figure 6. Trend Channel Using Trendlines of Best Fit

Using Fibonacci Extensions can also be used to determine exit points, as the extension levels are drawn based on recent price action.

How to Use Trendlines in Trading – TakeAways

  • Trendlines are guidelines only, not exact levels. They provide areas the price could move to in the future. Don’t expect the price to move exactly to the trendline; it may not quite reach or it may overshoot.
  • Price action is important, and should always be used in conjunction with trendlines. Always be looking for higher highs and higher lows in an uptrend. If a lower high or lower low occurs, the trend may be in jeopardy. Look for lower lows and lower highs in a downtrend. If a higher low or higher high occurs, the downtrend may be in jeopardy.
  • Trendlines often have to be redrawn. You may end up with multiple trendlines at different angles for the same overall trend. “Lines of best” will reduce the need to redraw trendlines, although the best fit line may still need to be adjusted.
  • Trendlines can be drawn anytime we have two waves in the same direction. When starting out, draw lots of trendlines as it helps show short-term and long-term direction.
  • Trendlines are a visual guide to cut through noise, and therefore may aid in seeing trade setups. The trendlines themselves do not generate trade signals. Rather, we wait for a trade trigger near a trendline to get us into a trade aligned with the trend.

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By Cory Mitchell, CMT @corymitc

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4 thoughts on “ How to Use Trendlines for Trading – Dispelling the Myths ”

In a hypothetical strong uptrend, where the price has broken the overall/current trendline significantly but remains above the previous major swing low indicating that the uptrend is for the time being still intact, when and how do you look to re-enter long? Given that there are no visual aids such as a further trendline to indicate where support might exist, how do you determine which consolidation breakout is worth entering on, or is it a case of taking every opportunity till price proves otherwise?

Or is it simply a case of not taking trades that go beyond the trendline and to wait to see if the uptrend resumes, and then to look to enter a trade when price pulls back to the newly adjusted trendline? The caveat I see with this approach is that by the time this occurs much of the move may be over and the overall trend weakened.

Thank you very much for taking the time to read this rather long-winded question, and I very much hope to hear your thoughts on this subject.

Great question Jimmy.

First I would say that a trade should never be taken unless it is based on a pattern/strategy that you know. I swing traded for a while entirely on trend channels. I only took a trade if I a got a setup near my trendline. The strategy did very well, because if the price did something where it moved away from my trendline, I simply didn’t trade. I also only traded stocks and currency pairs that had a major tendency to adhere to these trend channels.

BUT, it is good to be more versatile than that. Sometimes prices respect trendline and channels very well, but lots of time they don’t. So some flexibility is good.

Trendlines are just a visual, but can also be deceiving when the price breaks through them but doesn’t actually change the trend.

That is why I always spend some time before a trade looking at how deep the typical pullbacks are. I do this while day trading or swing trading, and as soon as I pull up a chart I start looking for tendencies. Usually, I am looking for percentage retracements. For example, I may notice that a price often retraces about 60% to 70% of the last advance during an uptrend, before moving higher again. Of course, each pullback will be slightly different, but it provides a ballpark area to look for trades. At that point, I only take trades signals (such as a consolidation breakout or an engulfing pattern) that occur in that pullback area. I can then make adjustments to this based on the velocity and magnitude of the price waves currently underway (http://vantagepointtrading.com/archives/11068). You can also look for other little tendencies, such as how many little waves the pullback has (is it just dropping in one or two bars, stopping for a bar, and shooting higher? Or is the price making 3/4/5 little waves before reversing back in the trending direction—-all these tendencies can help determine when the best time to take a trade is).

For retracement percentages I don’t concern myself with Fibonacci ratios, but the Fibonacci tool is an easy one to use quickly see how far retracements are typically moving (http://vantagepointtrading.com/archives/10451)

So I am using the tendency of the stock/currency/contract to tell me where it is likely to go. And like I mentioned initially, I then only take trades when a trade signal occurs in that anticipated trade area. If forex pair usually retraces about 50% of the advance, I am only going to look for trades in that area (close to it, not exact). If the price only retraces 25%, and then forms a trade signal, I skip it. There will still be losing trades, for example, the price could retrace 50% (if that is the tendency), form a trade signal and then keep going against me. That’s a loss. Wait for the next opportunity.

Basically, I only take trades based on evidence that I can find, and that aligns with my broader strategy. Sometimes that may be a trendline if the price has shown continual respect for trendlines. Other times I may be looking for other tendencies. But unless I know what that tendency is, I don’t trade. If the chart just looks like chaos, I don’t trade.
I should note that these tendencies vary by stock, forex and futures contract. If day trading, they also vary by day. So I am always trying to pick out the relevant tendencies for that specific asset, on that specific time frame.

A lot more information here, but hopefully that helps you start to formulate a more concise plan for what you do in these situations.

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