After some time fiddling around with technical analysis, it doesn’t take long to understand the power of trendlines.
They are one of the most useful tools in the support and resistance arsenal and can be used not only to understand the structure of the market, but they can be used to make actionable trading decisions.
One of the most common ways they are used in the latter sense is with breakouts. By identifying a great trendline, one can identify a great breakout.
They can also be used for stop protection, or maybe even an entry point for a range trade.
As great as they are as a tool though does not necessarily translate in them being easy to use or identified correctly in a consistent manner.
One of the frequent questions I have received in my quest to help others with their technical analysis training and development is “How do I know which trendlines to place and where?” Very straightforward question should deserve a very straightforward answer until one actually ponders how to accurately describe the process of placing great trendlines without being able to use a visual to simply say “that’s what one looks like.” Today, I will attempt to give some pointers on correct trendline placement although don’t look at this as a definitive guide, but rather something to think about when you are placing your own trendlines.
Also, remember that placement of horizontal s/r and tendlines, although we attempt to be as mechanical and systematic in our approach, is still, in some ways an art/craft that must be developed and honed through practice, and experience. Just like any other skill that has to be learned, some people will naturally have an easier ability to pick up on it than others, but I feel that anyone can do it properly with enough practice.
If you are new to trading, don’t beat yourself up just because your trendline didn’t end up reflecting the market. Give it time and practice and you will be able to have the confidence in their powerful ability to reflect the market. If you have been doing it a while and still don’t feel that way, understand that there is always room for improvement and if you keep at it, there is no reason things won’t eventually fall into place.
- Higher Timeframes=More Important/Impactful Trendline: This is very important to understand and potentially even show reflected in your trendline color or thickness. What I mean is that when a trendline is found on a higher timeframe, it generally has a much stronger force than say a trendline found on the 5-minute chart. Breaks of monthly trendlines will likely have a bigger impact on the market than one found during the day on the 1-minute chart. Trades should be understood according to this principle as well. Don’t look for an earth-shattering move if you have created a 15-minute trendline that covers a few days, and likewise, breaks of a daily trendline can probably produce a bigger move than a 10-pip scalp.
- 3-Point Touch: One of the most important factors I have found is that my best trendlines are established when THREE or more points all convene on the same line. I don’t mean spiked through, and I don’t mean “almost touched”. The best trendines start with a recipe of price rejecting exactly at a diagonal line 3 times or more.
- Extreme Behavior: A common question is “should I use the bodies of candles or the spikes?” I have found better trendlines often use extreme touches where price reverses solidly after a touch to establish them. Once you have identified these strong reversal points, generally speaking, the future use of the trendline is strengthened. So use the spikes when possible, unless a smaller spike one or two candles away makes more sense and gives you more accurate touches.
- Encapsulation: It is perfectly fine if you see spikes through the trendline, and even the occasional small break or “fake-out”, but in the majority of great trendlines, price does not close above, below, above, below or swing through the line on closed candles of the timeframe in which the trendline was established. A good trendline should encapsulate all the data without multiple breakouts. After all, we want to identify THE AREA of breakage to trade. Good trendlines will keep price “corralled” until a real breakout happens. I know this is a little obscure, but I’m sure man of you have used a trendline initially, that didn’t lead to clean breakouts, and then later you saw if you had only used different points, you would have seen the breakout never really happened, but the trendline was simply wrong.
- Confirmation Related To Timeframe: This one is simple: If you created a trendline on a timeframe, ONLY that timeframe or HIGHER confirms a breakout of the timeframe. It is very common to see monthly trendlines break on the hourly, 4-hour or daily, and then by the end of the month, come right back inside only producing a spike. Don’t get fooled by this. One way around this is to color code your trendlines based on timeframe. That way, if you have a blue trendline representing the daily chart establishing it, you will know to only look for daily or higher moves confirmed. Don’t get too carried away with this though, as a 5-minute trendline may not even matter on the daily or weekly timeframe and looking for a confirmed breakout of this area on a much higher timeframe simply doesn’t work either. Keep the moves close to the timeframe in which it was established, but only ever in the higher timeframe direction for confirmation.
Well, I hope that helps a little with trendline placement, verification, and trading from them. Trendlines can be a very powerful tool in the technical analyst’s kit if used properly and it behooves all of us to learn and become proficient at them!! Happy trading!!!
Here is a video that Marc Walton recorded a few years ago that shows you the basics for creating support & resistance trend lines. For a more up to date, complete (FREE) mini course on the subject of trend lines & support & resistance CLICK HERE
Author: Omar Eltoukhy
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