How to Draw Trendlines?

How to Draw Trendlines?

What’s an analyzed chart without a trendline? The answer is simple! An analyzed chart without a trendline is like a map without routes. Just like a map needs plotted routes to amplify specific directions, a cryptocurrency chart needs trendlines to aid traders in finding the market’s direction.

Trendlines are one of the most popular charting tools, and almost all traders utilize this tool for analysis. If you want to know how and when to use trendlines and take your technical analysis skills to the next level, then this article is just for you. But first, what exactly is a trendline?

What are Trendlines?

Trendlines are straight lines that traders draw on charts to connect significant support and resistance levels. The line gives a clearer picture of where the market is headed. Trendlines make it easier for traders to identify the price’s direction, join the trend, and snipe entries at better price levels.

Interestingly, trendlines reveal a lot more than the market’s direction. Trendlines also reveal the speed of price movement and amplify demand and supply zones. Although trendlines are very simple tools, just a straight line and nothing more, they can be used to make big trading decisions if used effectively.

It is easy to decipher the price range of cryptocurrencies with trendlines. Sometimes, the market could be in an uptrend; other times, it could be a downtrend. Still, at other times, prices could move horizontally, thus creating a ranging market.

Uptrend vs. Downtrend

In trading, an uptrend refers to a general upward movement or trend in the price of a cryptocurrency. This means that the price increases significantly over time. During an uptrend, there could be pullbacks in the price, but overall, the crypto asset increases in value.

A downtrend, on the other hand, refers to a steady downward movement in the price of an asset. This means that the crypto’s price decreases over a while. Drawing trendlines makes it easier to identify trends and understand the market’s direction.

How to Identify and Draw Trendlines

To identify and draw a trendline, follow these simple steps:

1. Identify the trend: The first thing to look out for is the trend or price’s direction. Is the price of the crypto asset steadily increasing or decreasing? To answer this question, search for a series of data points that are either consistently increasing or decreasing.
2. Select your starting and ending points: Select two data points that you will use to draw your trendline. These should be points that are at opposite ends of the trend. The starting and ending points should not be too far apart.
3. Connect the points: Use the trendline tool on your chart to connect both points. The two points to be connected should be support levels or resistance levels. Notably, you could connect more than two points – three, four, or more on rare occasions.
4. Extend the trendline: Continue drawing the line beyond your starting and ending points to see how the trend might continue in the future.
5. Ensure Accuracy: Check that the line passes through as many data points as possible and that it represents the overall trend in the data.

In a nutshell, a perfect trendline connects two or more resistance points or support points. Support levels are usually connected with each other, and resistance levels are connected with each other.

The Bitcoin chart above shows a trendline connecting three support points. The trendline captures an upward trend for BTC in the 3-hour timeframe. Note that a trendline may have overlapping wicks since trendlines are about identifying the market’s direction rather than extremely specific price points.

The Wrong Way to Draw a Trendline

The key thing to have in mind when drawing a trendline is to identify the trend, support and resistance points, and significant price levels to expect a price reaction. Interestingly, while having these in mind, you may still not get it right.

The first pitfall to avoid when drawing a trendline is making it too steep. A trendline should have the appearance of a slope. However, an extremely steep slope will form a terrible trendline. The image below exemplifies a very steep slope and a bad trendline.

Source: TradingView

In addition to the steepness of the slope, the points connected make the trendline a very bad trendline. Trendlines should connect clear resistance levels or support levels, not just any two price points.

How to Trade with a Trendline

There are different trendline trading strategies. Since many trading techniques require traders to identify the market’s direction, trendlines are almost always needed. The trend is your friend, so always flow with it unless it gets broken. When it gets broken, you can trade breakouts if the chart shows a strong reversal sign.

Trading With the Trend

Traders use trendlines to identify support and resistance levels. Rather than rigidly sticking to the line, traders tend to stick to the level or region. Thus, traders watch out for the reaction at this price level once the trendline has been drawn and the price approaches the trendline.

Image Source: TradingView

From the image above, Bitcoin’s price trod down the slope, which was confirmed by the trendline. The trendline connected three significant price levels or resistance points.

The trendline helps traders to look out for selling or shorting opportunities. After connecting two or three resistance levels, a sell position can be activated when the price retests the trendline again.

Trading Breakouts

Trendlines can also be used to trade breakouts or trend reversals. After a long bearish or bullish run, the market may be set to reverse. Trendlines make it easy for traders to spot when to enter a market or not.

Image Source: TradingView

Nothing lasts forever, not even bearish trends. In the Bitcoin chart above, bearish traders must have enjoyed shorting the market from the $36K region to below $30K. As expected, the trend eventually halted, leading to a breakout in price.

When the price breaks out from a trendline with huge volume, that could signal a change in trend. Bitcoin broke the trendline around the $32K region, and the candlestick formed above the trendline reveals that the buying pressure was high.

Some breakouts may be accompanied by a retest of the trendline, while others may not. In this case, the price did not retest the trendline before keeping up with its bullish momentum.

Confirming Buy and Sell Entries with a Trendline

In the trading world, it is a grievous offense to enter or exit the market using data from trendlines alone. Trendlines work harmoniously with chart patterns, demand and supply zones, and even indicators. Here are some of the most common data to combine with trendlines for improved accuracy.

Candlestick Formation

As the price approaches a trendline, the candlestick formation can be used to confirm a potential reversal. For a trendline connecting two resistance levels, a bearish reversal may be imminent if the price approaches the trendline a third time and the green candles formed around this region keep getting smaller. Smaller-sized green candles indicate that the buyers are losing their strength.

The formation of bearish reversal candlesticks as the price approaches the trendline is another positive signal in a downtrend. The shooting star and the bearish engulfing candle are the strongest bearish reversal candlesticks to depend on. When spotted around the trendline on a downtrend, you should get ready to push the sell button.

Moving Average

Trendlines are also used with moving averages to confirm entries or exits. Moving averages show an asset’s average price at specific data points and timeframes. You can place a sell entry for a downtrend when the price hits the trendline resistance and moves below the moving average. Likewise, you can create a buy order for an uptrend when the price hits the trendline support, then moves above the MA.

When using the exponential moving average, the golden cross signals the region and time for the entry. When the EMA crosses from beneath in an uptrend, around the region of the trendline’s support, that could be a good buy. Similarly, when the EMA crosses from the top in a downtrend and the price heads south close to the trendline’s resistance, that creates a selling opportunity.

Volume

Volume is a vital metric when trading with the trend or trading breakouts. The volume on the price chart reveals the strength of buyers and sellers. When a crypto’s price approaches the trendline’s support and is supported by a high buy volume, buyers are ready to push the price upwards. The reverse is the case when the buy volume is low.

Advantages of Trading with a Trendline

1. Trendlines are easy to draw: Trendlines make it easy for even newbies to detect a cryptocurrency’s price direction and the rate of price change.

2. Trendlines can offer a huge RRR: When trading with trendlines, traders can afford to use a slim stop-loss. This gives the trader a higher risk-to-reward ratio (RRR), that is, the lower risk with higher rewards.

3. Trendlines can be used in every timeframe: Whether it is the 5-minutes TF or the 1-Day timeframe, trendlines can detect bullish or bearish sentiments.

Disadvantages of Trading with a Trendline

1. Trendlines are based on past data: Trendlines are drawn using past data, so they may not accurately reflect future price movements.

2. Trends can change: Trends can change over time, and a trendline that was once accurate may no longer be relevant.

3. Trendlines are subjective: No specific support or resistance should be used to draw a trendline. The choice of starting and ending points for a trendline can be subjective, which can affect the accuracy of the trendline.

Conclusion

A trendline can be useful for identifying trends and forecasting price movements, but you can not rely on it alone. Traders should be careful to use them in conjunction with other analysis techniques and indicators. While doing this, risk should also be managed effectively. Finally, test different trendline strategies in a demo account before using them in live trading.