Trend lines have become widely popular as a way to identify possible support or resistance. But one question still lingers among Forex traders – how to draw trend lines?
In this lesson we’ll discuss what trend lines are as well as how to draw them. I’m also going to share a secret way that I like to use trend lines to spot potential tops and bottoms in a market, so be sure to read the lesson in its entirety.
As the name implies, trend lines are levels used in technical analysis that can be drawn along a trend to represent either support or resistance, depending on the direction of the trend. Think of them as the diagonal equivalent of horizontal support and resistance.
These trend lines can help us to identify potential areas of increased supply and demand, which can cause the market to move down or up respectively.
Let’s take a look at a trend line that was drawn during an uptrend.
Notice how in the GBPUSD daily chart above, the market touched off of trend line support several times over an extended period of time. This trend line represented an area of support where traders can begin to look for buying opportunities.
Now let’s take a look at a trend line that was drawn during a downtrend.
Similar to the GBPUSD uptrend in the first chart, this AUDNZD downtrend touched off of our trend line several times over an extended period of time. The difference is that the trend line above represents a downtrend, during which time it acts as resistance, giving traders an opportunity to look for selling opportunities.
Now that we have a good understanding of what trend lines are, let’s discuss how to draw them.
The very first thing to know about drawing trend lines is that you need at least two points in the market to start a trend line. Once the second swing high or low has been identified, you can draw your trend line.
Here is an example of the first two swing lows that have been identified.
Notice in the chart above, we have two main points at which we can start to draw our trend line. Once this level has been established, we can start to look for bullish price action to join the rally.
Sure enough, just a few weeks later a bullish pin bar emerged at trend line support.
The bullish pin bar above provided a signal to traders that the trend line was likely to hold. This gave traders an opportunity to buy at support to join the rally.
There are three very important keys to drawing effective trend lines.
Let’s take a look at each of these in greater detail.
Use the Higher Time Frames for Drawing Trend Lines
Just about everything I do in the Forex market begins on the daily time frame and drawing trend lines is no exception. One reason I prefer the daily time frame for drawing trend lines, besides the fact that I do most of my trading from this time frame, is that it represents an extended period of time.
This brings me to a very important rule regarding trend lines. The longer a trend line is respected, the more important it becomes. A trend line that extends over two years will always be considered more important than a level that only extends the course of two weeks.
Here is a great example of a trend line that was drawn from the daily time frame.
In the GBPCHF daily chart above, after the second swing low was made we could have drawn our trend line. Notice how the market formed a bullish pin bar at the third touch from this trend line. This is a perfect example of the type of buying opportunity a trader would look for using trend line support.
Another higher time frame that I like to use to draw trend lines is the weekly chart. This time frame is great for identifying potential targets during uptrends or downtrends on the daily time frame.
Here is a great example of how a weekly trend line on CADCHF can be used to identify a potential target.
The chart above shows a weekly trend line that can be extremely useful to identify a potential target for CADCHF. The daily time frame is in an uptrend at the moment, so this weekly trend line would give us a great starting place to look for a potential profit target.
Trend Lines and Overlap
One of the most common questions when it comes to drawing trend lines is, should they be drawn from the high/low of a candle or from the open/close of the candle. The answer to this question depends on the trend line.
It’s very rare to find a trend line that lines up perfectly with highs or lows. Similarly, it’s rare to find a trend line that lines up perfectly with the open or close of each candle.
Let’s take a look at an example
Notice how the trend line above does not perfectly line up with the highs of each candle, nor does it line up perfectly with the open or close of each candle. This doesn’t mean that the trend line is invalid. What’s important here is that the weekly chart above never closed above this level.
The most important part of any trend line is to get the most touches without the level cutting off part of a candlestick. If you find that a trend line cuts through the body of a candlestick, then the trend line is likely not valid.
Never Try to Force a Trend Line to Fit
This is perhaps the most common pitfall Forex traders make when drawing trend lines. We call this “curve fitting” and it happens when a technical trader is so convinced that a level should exit, that the trader begins to try to make the level fit the price action on the chart.
This brings me to the most important part about drawing trend lines, or any support or resistance level for that matter. The best trend lines are the most obvious ones. So if a trend line doesn’t fit well, it’s probably best to move on to another pattern.
As promised, I’m going to show you a way that I like to use trend lines to determine the strength of a trend. Moreover, this method can help you spot potential reversal points in the market.
At this point in the lesson, you know that a trend line can be used to identify potential buying or selling opportunities. But this only works as long as the market continues to respect the trend line as support or resistance. So what happens when the market no longer respects the level?
This is where you have a chance to trade a market as it makes a turn from a major swing high or low. Below is an example of a market that broke trend line support and then retested that same trend line as new resistance.
We can see in the GBPCHF daily chart above, that the pair had respected a trend line for some time. However once the market broke trend line support, it quickly retested former support as new resistance. This retest gave traders the opportunity to sell the pair, which would have resulted in a substantial gain over the next several days as the market sold off.
One thing to note about using trend lines in this way is that it works best when you have a really clean trend line with three or more touches. The more obvious the trend line is, the better this strategy will work.
We can also use this strategy to identify a bullish reversal.
Notice how shortly after breaking trend line resistance, the market came back to retest the trend line as new support and formed a bullish pin bar in the process. This gave price action traders an opportunity to buy just before the market rallied for 800 pips.
This is a great way to use trend lines to spot potential reversals in the market. It is without a doubt one of the best ways to catch a big move as a market changes direction.
I hope this lesson has given you a better understanding of how to draw trend lines and how they can be used in the Forex market.
We’ve covered a lot in this lesson, so let’s recap some of the important points.