Thus, charts are often supplemented with graphic representations of additional information. Trendlines are a perfect example. These are lines drawn above or below a price (sometimes at the price), used to give indications about the immediate trend and to signal future trend changes. Additionally, trendlines can also be used as support and resistance, providing opportunities to open and close positions.
- Trendlines are an essential tool in technical analysis.
- They help identify previous and potentially recurring market trends. Thus, they are used to determine when to enter or exit a position.
- Trendlines connect two (or ideally more) highs or lows in a straight line:
- A trendline connecting lows is referred to as support. It marks a level below which the price is not expected to drop.
- A trendline connecting highs is referred to as resistance. It marks a level above which the price is not predicted to rise.
- The area between the parallel support and resistance trend lines is referred to as a channel while a channel between horizontal support and resistance levels is called trading range.
- Channels and ranges can be used to determine the current market trend and indicate good trade entry and exit points.
The basics of trendlines
In order to increase the probability of making a successful trade, it is essential that you understand the direction of the underlying trends. This can increase the chances of the general market trends working in your favor.
Trendlines, as their name suggests, are lines drawn on trading charts (see the article on understanding Tradeview for more information) that help identify previous and potentially recurring market trends. A downward-sloping trendline suggests that there is an excess supply of the asset, signifying a bear market with dropping prices. An upward-facing trendline, by contrast, signals that the demand for the asset is greater than the supply, signifying a bull market with increasing prices. Many traders utilize trendlines to create auto-buys and auto-sells at different levels.
Drawing a trendline
While some analysts prefer to use short time frames, e.g. 1–5 minutes, others use much broader time windows, such as a week or a month. The most popular time frames include the daily and the 4-hour time frame, as large time frames tend to be more reliable. Then, there is a group of analysts who do not take time into consideration at all. Instead, they choose to view market trends based on tick intervals instead of time intervals. What makes trendlines so useful is that they help identify trends regardless of the time frame or interval used.
To draw a trendline, an analyst needs to have at least two high or low points, ideally three or more, to connect on a price chart. When connected by a line, the high or low points should form a straight line (disregarding formations such as parabolic trends, where the line is curved).
Support and resistance
In technical analysis, support and resistance are certain price levels that the price is not expected to cross. Analysts attempt to predict these levels by drawing a straight line that connects multiple highs or lows. The line then predicts a level beyond which a price is not likely to rise above (a resistance line) or fall below (a support line).
Support and resistance do not have to be horizontal. If the price is moving downward, a slanted resistance trendline can be drawn above the candlesticks, connecting multiple price highs. The general conception is that the price is likely to hit the resistance at least a couple of times before breaking through with new highs.
On the other hand, if the price trend is rising, a support trendline can be drawn below the price, connecting the lowest lows. The price is expected to rebound off the support a couple of times before eventually breaking it.
Whenever the price breaks through a resistance line, it can build confidence and drive prices higher. Whenever it breaks a support line, it can trigger a sell-off. If a support level gets broken it turns into a resistance and vice versa. This is called an “s/r flip.”
Range and channels
The gap between parallel support and resistance trendlines is known as a channel. There are three different types of channels depending on the price trend. An ascending, or up, channel is bordered by ascending support and resistance lines, and predicts an uptrend. A descending, or down, channel is bordered by descending trendlines and predicts a downtrend. When the price runs flat for a while, it is trapped in a horizontal, or sideways, channel, bordered by horizontal trendlines. A horizontal channel is sometimes known as a range.
Most frequently, channels are utilized in two ways:
- They let traders know what the state of the market is. Are we experiencing a bull run or is the market currently led by bears? Well-drawn channels can give a clear picture, allowing for a calculated response.
- They indicate good entry and exit prices by showing the support and resistance levels for the current trend.
Trendlines are a basic, easy to learn and effective tool to predict possible future market movements. They are incorporated into Bitstamp’s Tradeview on the left panel of the trading chart. All you need to start using them is to select the tool and connect the highs or lows on a price chart. With some practice, they may form a backbone of an effective trading strategy.