Trend Lines: How to View Your Charts - Part 1

[RichardCox 10]

Trend Lines: How to View Your Charts - Part 1

 

When we begin to watch price charts and learn technical analysis strategies, one of the first things traders will start to do is draw trend lines. But one of the earliest difficulties arises when traders become unsure with respect to how these trend lines should be drawn. The undeniable fact is that plotting trendlines is a highly subjective practice. What one trader sees as an uptrend or downtrend could be interpreted differently by another trader. Even the same trader could look at an identical situation on two different days and draw different conclusions. This ultimately means that developing a system that remains consistent and uniform is impossible to achieve.

 

There are no “correct” trend lines but some plots are able to capture the essence of the markets momentum better than others. So, it is important to focus on strategies that allow you to properly construct your trend lines so that you can have a more accurate way of viewing the market’s trajectory and take some of the subjectivity out of the equation. Ultimately, you will need to be able to arrive at clear definitions of trend line breakouts and determine price projections so that you can establish profit targets for your positions.

 

Understanding Trends

 

From a basic perspective, it is essential to have an understanding of what makes an uptrend or downtrend. When supply consistently exceeds demand, markets will experience bearish trends. When demand consistently exceeds supply, markets will experience bullish trends. These are the forces that create the market environment, and we can make visual representations of these activities using ascending slopes (increased demand) and descending slopes (increased supply). But when attempting to draw specific trend lines, difficulties arise when choosing the exact highs and lows to connect. This is where subjectivity enters the picture and this can prevent traders from seeing what is actually going on in the market.

 

Additional difficulties can arise from the fact that most traders are simply plotting from left to right on the price charts (going from past to present). The problem here is that not all time periods are created equal, and this approach fails to understand the more recent time intervals carry more weight than those further back historically. This is also the issue when dealing with things like an Exponential Moving Average (EMA) versus a Simple Moving Average (SMA). There are specific reasons why most experienced traders choose to use EMAs. Market conditions are constantly changing, so the most recent price information is what is going to give the most updated reflection of market sentiment.

 

Trend Line Construction

 

These factors can complicate the process of drawing trend lines. We are taught from an early age to read from right to left, but this does not need to be the case when we are assessing price charts. When looking to construct proper trend lines, it is important to develop patterns and strategies that conform to consistent practices. When regular practices are carried out in an imprecise way, we will sometimes see traders drawing multiple trend lines for the same move on their charts. The lack of commitment in constructing a single trend line can make it impossible to clearly define the trend or to plot specific areas for stop losses, profit targets, and trade entries. In all cases, we must select at least two price points to connect when drawing a trend line -- but a bigger number of connected support/resistance points can help to confirm the validity of the trend line. For downtrends, these price points will mark resistance areas that decline over time. For uptrends, these price points will mark support areas that rise over time.

 

But what most traders miss is the fact that these price points can be identified by looking from right to left. Of course, longer time frames produce more stable constructions than shorter term time frames. Consider the 4-H chart below in the EUR/USD. Price momentum has been positive in recent sessions, and this means we will need to find support points to connect when defining the trend line. Below, we can see four support areas (reading from right to left):

 

 

Here, we can see demand levels increase (demand is exceeding supply) and these areas create the uptrend. The chart below shows these four price points connected with an uptrend line:

 

 

The green line in the picture should now be viewed as the “demand” line, and we will expect prices to find support in this area going forward. The demand line becomes invalidated if we see an interval close below this line. Of course, the bearish scenario would show the reverse:

 

 

 

Notice in these examples that it is not necessary to perfectly connect the tops and bottoms of each set of price points. There will almost always be be cases where your trend line do not connect the support and resistance levels perfectly. It is not even necessarily desirable that these areas form a line that looks 100% perfect. Looking for these situations will only keep you out of trades that would have otherwise been successful. All you are trying to do here is assess the real trajectory of the market so that you can define your bias and place trades that are in-line with how the market is likely to unfold. Another important point to note is that we are categorizing the right-most point as (1), because we are looking at the chart from right to left.

 

Price Targets and Stop Losses

 

When we are looking to buy low and sell high (as high/low as possible), look to place your trade entries close to your supply/demand line. The reason for this lies in the fact that out trend line is the only information the market is giving us, and we will need to use this information to its best advantage. We do not want to see prices blow through trend lines, so it is important to see these areas tested first before entry. Once the market hits these areas and reverses, you have confirmation and can establish a trading bias.

 

For conservative traders, all you want to do is take your profits at the market’s previously established highs. For those with a more aggressive strategy, it is often the common practice to set profit targets above previous highs (or below previous lows) as the presence of a trend creates an increased probability that prices will extend beyond their previous ranges. In stop losses, conservative traders will generally want to set their trade exit above/below the trend line, because it is important to close the trade in cases where your your trend line is invalidated. The reason for this lies in the fact that your original trading idea was wrong and you need to close out before things get worse. All we have in technical analysis is the early information the market gives us. If this proves incorrect, accept it and move on. Those with more aggressive strategies will generally want to bring their stop losses to break-even once the previous support/resistance level is tested.

 

Price and Time

 

The next idea to consider is the fact that trend lines give us an idea of how to trade in terms of price levels and time intervals. This would be another area where new traders (and most traders) fail to understand the market environment. Trend lines give us two pieces of information -- not one. Slopes have an X and Y axis. This involves two variables, the second of which is time. So, when we are able to draw trend lines we are ultimately able to assess the dominant direction in which prices are likely to travel. We are also able to assess the length of time that will probably be needed in order for prices to reach certain highs or lows. In part 2 of this article, we will look at additional factors (i.e. support becoming resistance) as well as the Mouteki System which is another way of using trend lines as part of a trading strategy.

[SunTrader 10]

Trend Lines: How to View Your Charts - Part 1

 

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The undeniable fact is that plotting trendlines is a highly subjective practice.

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Which is why I use Tom DeMark TD Lines - which is where Mouteki got his inspiration too.

[Roger Felton 10]

Kudos to Richard Cox for his informative post on trend lines. I used trend lines way back when and found them useful, albeit somewhat subjective. I'd like to add my 2 cents to the topic in hopes some find the information useful.

 

I found using trend lines alone to be sort of like playing soccer on one leg. It was only when I began an extensive study of trend channels that things started coming together and subjectivity virtually vanished. There was one other missing piece of the puzzle that I'll cover in a minute. But first, let's look at Richard's two chart examples. In the downtrend chart (A), notice I have turned Richard's trend line into a trend channel by simply doing a parallel transport of the trend line to the intervening highs.

 

As Richard aptly pointed out, don't look for "to the tick" perfection. If Price goes to, through (a few ticks), or close to a trend channel line, call it good. No matter how many "connections" you get on the highs or on the lows, the trend channel does not confirm unless you get at least two highs and two lows...and they don't have to be a consecutive low, high, low, high sequence.

 

In Example (A), we see the two main things I look for...smooth volatility up and down with Price bouncing off the trend channel lines like a pin ball machine. Each bounce on an opposing color bar, can produce a new entry going counter-trend as well as with trend. The other thing I love to see is Price breaking a channel line...either top or bottom, it doesn't matter. In a down trend, if Price breaks the bottom (support) line, enter on the first bearish bar that forms completely outside the line. This means the trend is poised for a strong push to the downside and you'll often get a super entry price.

 

In Example (B), the uptrend, I have taken the liberty of constructing Richard's trend line into a trend channel...two of them actually as this is an example of a trend channel that jumped a level and then settled back down into the older channel's support line. The larger trend channel confirmed since it produced at least two tops and two bottoms that "kissed" the supply and support channel lines.

 

So, in addition to Richard's entry arrow examples, we now get a lot more trade entries when we use a channel instead of a single line to define our trend. Remember, you are looking for channel break outs in either direction and take the first correct color bar forming outside of the channel line.

 

One of the things that bugged he holy Hades out of me was the inherent massive noise that my time-based, tick, range, volume, etc. charts would produce...often causing misjudgments as to actual Price swing highs and lows. I looked at Linebreak charts and found them to be an improvement but still not what I wanted. I wanted a bar type that would naturally filter the majority of market noise and give me clear, clean Price movement and enable me to identify good strong trend channel formations.

 

About 3 years ago I began to study Renko bars. At that time they weren't all that I wanted but I could see the potential. After tweaking the code a bit, I got what I wanted and I had trend channels I could easily identify and trust. I had a dozen of my students independently draw the trend lines for an entire day on the same instrument and timeframe and they were all identical to each other and to mine. Subjectivity was toast. After doing hundreds of webinar presentations and free training sessions, I am now seeing more and more traders, platform providers, system and education providers making the switch to this amazing bar type. Don't buy it, they are now all over the Internet and free.

 

With this in mind, now take a look at Example © which is the bar type I now use exclusively and a perfect choice for drawing trend channels. This bar is a 14,7 Renko which means the colored portion of the bar is 14 ticks in size and the "step" size is 7 ticks. That means that the price difference between the close of one bar to the close of the next of the same color is 7 ticks. Any set of number choices can be used from a 2,1 to a 80,40 or more (imagine making 40 ticks and only in for one bar!). When choosing, I look for the best, smoothest cycling volatility and these settings usually hold for several days, weeks or even months.

 

Each time the market hits the support or supply lines of the channel, it presents a trade opportunity. It's beyond the scope of this post to try to teach how to filter trade opportunities, but it's a very worthwhile skill to learn especially when going counter trend. Notice there were two channel breakouts in this example and both worked quite well. Both occurred in the downtrend...one on the first down arrow and one on the final down arrow.

 

Here in Crude Oil (CL), each tick is worth $10 and there are 10 ticks to the point. So, trading just 2 contracts and taking just two bars here, you could bag $280 before comm. and often in just a few minutes since bounces off of channel lines are known for launching brisk market moves.

 

I personally trade futures exclusively since, for me, they offer the highest potential for profit, with the least amount of risk in the shortest period of time overall. However, if you find that you are meeting your goals consistently in other venues such as the Forex, then by all means stick with it. This technique works equally well.

 

Hope this was of benefit to some of you.

[SunTrader 10]

I believe, from following Tom DeMark's TL methods, the key is to have qualifiers as to whether a TL break will succeed or fail. In other words whether to enter with the trend or fade it.

 

Use swing points of similar or lower strength looking from the current one back to the most recent previous swing point (only). So two swing points is all that is needed. No touches, channels, or any other such extras.

 

A line is either qualified or not which determines the likelihood of market direction. Simple.