A trendline is a line drawn over pivot highs or under pivot lows to show the prevailing direction of price. Trendlines are a visual representation of support and resistance in any time frame. They show direction and speed of price, and also describe patterns during periods of price contraction.
A single trendline can be applied to a chart to give a clearer picture of the trend.
Trendlines can be applied to the highs and the lows to create a channel.
The time period being analyzed and the exact points used to create a trendline vary from trader to trader.
What Do Trendlines Tell You?
The trendline is among the most important tools used by technical analysts. Instead of looking at past business performance or other fundamentals, technical analysts look for trends in price action. A trendline helps technical analysts determine the current direction in market prices. Technical analysts believe the trend is your friend, and identifying this trend is the first step in the process of making a good trade.
To create a trendline, an analyst must have at least two points on a price chart. Some analysts like to use different time frames such as one minute or five minutes. Others look at daily charts or weekly charts. Some analysts put aside time altogether, choosing to view trends based on tick intervals rather than intervals of time. What makes trendlines so universal in usage and appeal is they can be used to help identify trends regardless of the time period, time frame or interval used.
If company A is trading at $35 and moves to $40 in two days and $45 in three days, the analyst has three points to plot on a chart, starting at $35, then moving to $40, and then moving to $45. If the analyst draws a line between all three price points, they have an upward trend. The trendline drawn has a positive slope and is therefore telling the analyst to buy in the direction of the trend. If company A’s price goes from $35 to $25, however, the trendline has a negative slope and the analyst should sell in the direction of the trend.
Example of How to Use a Trendline
Trendlines are relatively easy to use. A trader simply has to chart the price data normally, using open, close, high and low. Below is data for the Russell 2000 in a candlestick chart with the trendline applied to three session lows over a two month period.
The trendline shows the uptrend in the Russell 2000 and can be thought of as support when entering a position. In this case, trader may choose enter a long position near the trendline and then extend it into the future. If the price action breaches the trendline on the downside, the trader can use that as a signal to close the position. This allows the trader to exit when the trend he or she is following starts to weaken.
Trendlines are, of course, a product of the time period. In the example above, a trader doesn’t need to redraw the trendline very often. On a time scale of minutes, however, trendlines and trades may need to be readjusted frequently.
The Difference Between Trendlines and Channels
More than one trendline can be applied to a chart. Traders often use a trendline connecting highs for a period as well as another to connect lows in order to create channels. A channel adds a visual representation of both support and resistance for the time period being analyzed. Similar to a single trendline, traders are looking for a spike or a breakout to take the price action out of the channel. They may use that breach as an exit point or an entry point depending on how they are setting up their trade.
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Trendlines have limitations shared by all charting tools in that they have to be readjusted as more price data comes in. A trendline will sometimes last for a long time, but eventually the price action will deviate enough that it needs to be updated. Moreover, traders often choose different data points to connect. For example, some traders will use the lowest lows, while others may only use the lowest closing prices for a period. Last, trendlines applied on smaller timeframes can be volume sensitive. A trendline formed on low volume may easily be broken as volume picks up throughout a session.
Excel Trend Function
Equation for a Straight Line
The Excel Trend Function finds the linear trend by using the least squares method to calculate the line of best fit for a supplied set of y- and x- values.
If there is a single range of x-values, the calculated line satisfies the simple straight line equation:
x is the independent variable;
y is the dependent variable;
m is the slope (gradient) of the line;
b is a constant, equal to the value of y when x = 0.
If there are multiple ranges of x-values, the line of best fit satisfies the following equation:
the x’s are the independent variable ranges;
y is the dependent variable;
the m’s are constant multipliers for each x range;
b is a constant.
The Excel TREND function calculates the linear trend line through a given set of y-values and (optionally), a given set of x-values.
The function then extends the linear trendline to calculate additional y-values for a further supplied set of new x-values.
The syntax of the function is:
Where the function arguments are as follows:
An array known y-values.
One or more arrays of known x-values.
This is an optional argument which, if provided, should have the same length as the set of known_y’s .
If omitted, the set of [known_x’s] takes on the value <1, 2, 3, . >.
An optional argument, providing one or more arrays of numeric values representing a set of new x-values, for which you want to calculate the corresponding new y-values.
Each array of [new_x’s] should correspond to an array of [known_x’s] .
If the [new_x’s] argument is omitted, it is set to be equal to the [known_x’s] .
An optional logical argument that specifes whether the constant ‘b’, in the straight-line equation y = mx + b, should be forced to be equal to zero.
If [const] is TRUE (or if this argument is omitted) the constant b is treated normally;
If [const] is FALSE the constant b is set to 0 and the straight line equation becomes y = mx.
The Trend Function as an Array Formula:
If more than one new y-value is to be calculated by the Excel Trend function, the new values will be returned as an array. Therefore, the function must be entered as an Array Formula (see the examples below).
To input an array formula, you need to first highlight the range of cells for the function result. Type your function into the first cell of the range, and press CTRL-SHIFT-Enter.
See the Excel Array Formulas page for further details.
Trend Function Examples
Example 1 – Extension of a Simple Straight Line
In the spreadsheet below, the Excel Trend Function is used to extend a series of x- and y-values that lie on the straight line y = 2x + 10. The known x- and y-values are stored in cells A2-B5 of the spreadsheet, and are also shown in the spreadsheet graph.
Note that, it is not essential that the supplied points fit exactly along the straight line y = 2x + 10, (although they do in this example). The Excel Trend function will find the line of best fit for any set of values provided to it.
The Trend function uses the least squares method to find the line of best fit and then uses this to calculate the new y-values for the provided new x-values.
In this example, the values of the [new_x’s] are stored in cells A8-A10 and the Excel Trend function has been used, in cells B8-B10, to find the corresponding new y-values. As shown in the formula bar, the formula is:
It is seen that the Trend function in the formula bar is encased in curly braces < >. This indicates that the function has been input as an Array Formula.
Example 2 – Trend Function With Multiple Sets of Known X-Values
In the above spreadsheet on the right , the Excel Trend Function is used to extend a series of y-values that correspond to three sets of x-values.
The known x-values are stored in cells A2-C6 and the known y-values are stored in cells D2-D6 of the spreadsheet.
The set of new x-values is stored in cells A9-C11 and the Excel Trend function, which has been entered into cells D9-D11, is used to find the corresponding new y-values.
As shown in the formula bar, the formula for the Trend function is:
Again, it can be seen that the Trend function in the formula bar is encased in curly braces < >, showing that it has been input as an Array Formula.
For further examples of the Excel Trend function, see the Microsoft Office website.
Trend Function Errors
If you get an error from the Excel Trend function, this is likely to be one of the following:
What Does a Trend Line Really Tell Us?
We all know what a trend line is, but does a trend line actually dictate the trend? In other words, does a trend line break actually signal a trend reversal? Or, is a trend line break telling us something else? We cannot use a tool unless we fully understand it and this article will shed some light on the humble trend line. At the very least, I hope to stimulate the analysis process by challenging you to think hard about an indicator and its message.
At its most basic, a trend line is a line that connects a series of rising troughs or falling peaks. A rising trend line slopes up and reflects the rate-of-ascent based on the higher troughs. Thinking back to junior high math, this is simply the rise over the run. The steeper the upward slope, the faster the advance. A falling trend line slopes down and reflects the rate-of-descent based on the lower peaks. The steeper the downward slope, the faster the decline.
It takes a least two points to draw a trend line. Traditional technical analysis teaches us that validity increases along with the number of touches. As with all technical tools, trend lines are sometimes great at identifying trend changes, and sometimes not. The chart below shows Apple breaking a trend line that was touched at least four times. The sharp break certainly looked convincing at the time, but the stock bottomed soon after the break and moved to new highs.
The next example shows Agilent with a bullish trend line break that held and signaled the start of an extended advance. After a 40+ percent advance, the stock broke the green trend line in late July. This break, however, did not last long as the stock quickly recovered and move to a new high.
When drawing trend lines, chartists can choose between thin trend lines that are exact or thick trend lines that are “less exact”. The chart below shows the Retail SPDR (XRT) with a trend line (red) that touches the December and April highs, but just misses the early August high. The gray trend line, which is thicker, touches the April high, which means there are three touches. The lesson here: use a thicker line if you want more touches. Personally, I have no problem with thick trend lines because they are basically momentum indicators (think slope).
The indicator window shows 14-day RSI breaking to its highest level of the year this past week. Notice that this breakout coincides with a trend line break. The slope of this trend line measures the rate-of-descent, which is a form of momentum. RSI also measures momentum and the advance over the last four weeks achieved a momentum breakout. Notice that RSI hit its highest level of the year. This is also true for XLE and XES. A momentum breakout and trend line break, however, are not the same as a trend reversal. In other words, XRT has not moved from downtrend to uptrend. All we have seen is a change in downward momentum based on the lower highs that make up the trend line. The trend is still down because XRT hit a new low in August and has yet to take out the early August high. An uptrend requires a higher low AND a higher high so XRT has more work to do.
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How do I draw a trend line on a chart?
To draw a trend line on your chart, simply follow the steps below:
Here is an image of where you can find the Trendline tool:
To learn more about the ChartNotes annotation tool, please refer to our ChartNotes Annotation Tool – User Documentation page. Additionally, you can watch our video on how to draw a trend line.
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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.
Monitor Price Movement of Trends
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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