In previous chapter we discussed basics of trend line. You should read that chapter first before starting with this one. That chapter gives you basic idea about Trend Line and is required to follow content of this article. In case you have that basic idea then you can skip that chapter.
In this chapter we will see some important characteristics of Trend Line one should know. These help you understand them better and identify specific clue which you can use to set up your trading plan.
Trend Line Characteristics
1. Identify Valid Trend Line
This is perhaps most important aspect of drawing trend line. It should touch more than 2 points. That is prices should touch trend line more than two times for it to be valid trend line.
Note we can draw a line using 2 points only but that would not be valid line. In below image I am showing you example of valid and invalid trend line for clarity. In below image A is valid trend while B, C and D are invalid trend lines.
2. Trend Line acts as Support and Resistance
If you closely see above image line A has been touched many times. The prices come to touch the line if they are far off from the line. Line A acts as a support level. Prices will touch and bounce from the support in a uptrend.
In a downtrend the reverse will happen. Trend Line will act as a resistance level. Prices will touch the level and fall down. You can visit my article on Support and Resistance in case of any doubts or more information on this topic.
3. Trend Line break
In recent articles we have mentioned that Trend gets reversed if support or resistance is broken. Above we said trend lines work as support and resistance. Now we will extend trend reversal and see how trend lines help us identify them.
Intraday Trend Line break is not that important. The prices should close below trend line for two successive days. If the prices close below trend line for two or more days then it is said to be reversal. If not then original trend may continue.
Note Intraday penetration for two or more days is not considered only the closing prices are considered.
4. Role Reversal Trend Lines
In support and resistance chapter we saw that Support becomes resistance and vice versa. They reverse their roles depending on the direction of price movement. The same concept is applicable for Trend Lines as well.
We have already discussed that trend lines act as support and resistance. So trend lines reverse their roles in opposite movement. Now resistance and support are price points whereas trend lines are lines drawn in direction of price movement.
In above image a drew a line parallel to uptrend line. That line gives you resistance points. Note that around resistance point of 10,600 the prices faced difficulty to cross over and are traded for few sessions. The prices are moving downwards as well.
5. Trend Lines are Subjective
The only problem with Trend Lines are that they are subjective. New users tend to draw the lines based on their assumption. If they assume prices will go up then they will draw lines in that way.
Note due to this subjective nature of it people have come up with tool which we will see in later parts of technical analysis guide.
So if you have trouble identifying a pattern then it is better to avoid trading. You should wait for the moment till the pattern is clear enough for you to trade. If it is not clear then you can refrain from trading the security.
So remember before drawing the lines that your personal assumption or bias should not creep in. That would impact the decision making and you will lose the trade.
Trend Lines are tool which should not be used by Beginners to set up trade. It should be practiced and once you are good at drawing and understanding it then only you can start trading using it. There are many patterns which we will discuss in next set of tutorials. So stay tuned.