Trend Lines – How to use them correctly

The trend line is probably the most used and oldest tool. It is actually a very primitive tool, yet it is effective when drawn correctly.

About right and wrong trend lines

In most cases, the trend line connects at least two points. In the ideal case, they even have a logical connection. The expressiveness of a line increases if there is technically an inner connection. A trend line that would be part of a shoulder-head-shoulder formation or a flag is more important than just two points that are connected. The following figure 1 shows an unrelated collection of different trend lines. The most important rule is that a trend line consisting of two points should not be disturbed by an intervening price movement.

The upper picture shows that in every chart a multitude of trend lines can be drawn. There are hardly any limits to the imagination. This also makes it clear that subjective perception plays a major role. A good or bad trend line is therefore not defined by the analyst, but by the later course of the price.

An oblique trend line must have a sufficient length, because the effect of a too short trend line is limited. Two support points that are close to each other allow only an inaccurate statement about resistance and support. The rule applies that with an oblique trend line the distance of the outer support points forms approximately the forecast length.

In the upper picture the length of the trend line not. The distance between the support points determines the maximum effect of the trend line. This means that the closer the support points are to each other, the less effective the trend line is.

A trend line with an angle of inclination is less important than a horizontal line

When drawing trend lines in a chart, focus on horizontal lines. What was shown as a forecast error in Figure 2 does not apply to the horizontal line. Their effect can be very long – sometimes over years.

A horizontal trend line may even be drawn with only one support point (for example, a peak or bottom). A horizontal line is always correct! One may only discuss about the strength of the horizontal line.

The picture above shows a horizontal trend line that is touched at several points. The horizontal line works in both directions, up and down. With arrows the important points of the trend line touching points are marked.

Both resistance and support

Figure 3 showed the special quality of the horizontal trend line. It is effective for rising and falling prices. If the price comes to the line from below, then there is resistance. If the prices break through the resistance, it is not uncommon for the prices to show the first signs of exhaustion after a short upward movement. The prices then fall back. In this situation the former resistance line then becomes a support. Within an upward-trend, the prices bounce off the new support and the trend continues.

There is no single price that would be resistance or support

Analysts like to refer to certain price markers at which prices meet resistance or support. This is not entirely correct. While it is true that round price markers are attractive (such as 10000 DAX points or 50 euros), the effect comes as a self-fulfilling prophecy. In practice, no price marker is a resistance or support. There is always a support or resistance zone around this price marker. The zone can be wider or narrower, but it remains a zone.

Trend lines in the slope (angled)

Very often you will find a chart in an analysis in which angled trend lines are drawn. A common problem within these charts is that in most cases the analyst expresses a preconceived opinion. The trend lines drawn are subjective and are drawn to support his opinion. This is not really scientific, because another analyst may see completely different lines.

A second problem is the scaling of the chart. If you use an angled trend line with linear scaling, the same trend line with logarithmic scaling will show a different result. Which scaling would be correct? Both scaling types are common in technical analysis.

Provocatively, the question must also be asked, which trader uses angled trend lines to make a trading decision for entry or exit? This is probably only a minority. In practice, an angled trend line has a high error rate.

Trend Line Tips

Use horizontal trend lines preferably. Only draw trend lines in charts based on prices generated by supply and demand. Only then can you be sure that resistance and support will have an effect. For example, a trendline in the published series of figures on US initial unemployment benefits would be pointless. Study how prices behave when they touch a line. Prices tend to seek the path of least resistance. Look for probabilities and assume that nothing is impossible on the stock market.

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