What Is a Trendline?
Trendlines are easily recognizable lines that traders draw on charts to connect a series of prices together or show some data's best fit. The resulting line is then used to give the trader a good idea of the direction in which an investment's value might move. 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.Key Takeaways
- Trendlines indicate the best fit of some data using a single line or curve.
- 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 Using 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, a trader may choose to 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 they are 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.