Drawing Trend Lines
Trend lines are key elements of technical analysis and chart patterns as they indicate significant price levels where support of resistance could be expected to be encountered. Thus an understanding of trend lines, and what they represent, is important for successful trading based on technical analysis.
In an uptrend, which is characterized by higher highs and higher lows, with the higher lows referred to as correction lows or reaction lows as the market corrects an overbought condition, a trend line can be drawn below the correction lows connecting two or more of the lows. A trend line that connects only two correction lows is a tentative trend line and is only confirmed when the price test the line successfully, i.e., the price touches the line and bounce s of it, for a third time. When a trend line has been identified, it can used to identify potential areas of support for subsequent correction lows. Should the price breaks the trend line, i.e., penetrate or violate the trend line and close below it, then trend could be broken. However, only a lower low will confirm a reversal of the uptrend. In addition, an increase in volume at the break increases the validity of that break while a decrease in volume increases the probability of a false break. Furthermore, the actual drawing of trend lines is more of an art than a science and take a bit of time to get right. As a guideline, drawing the trend lines along areas of congestion rather than at the tips of the spikes is the preferred method for most technical analysts.
The same is true for a downtrend, which are characterized by lower lows and lower highs. The lower highs are referred to as reaction or correction highs as the market attempts to correct oversold conditions. A trend line can be drawn above the trend to connect two or more correction highs. When the trend line connects only two correction highs, it is a tentative trend line and is only confirmed when the price tests the trend line a third time without violating it. These trend lines are potential areas of resistance for subsequent correction highs. When the price penetrates the trend line and close above it, then trend line could be broken but a reversal of the downtrend is only confirmed by a higher high.
The strength or significance of a trend line increases every time the price returned to test the trend line without violating it. In addition, trend lines on charts with longer time frames have a greater significance than trend lines on charts with shorter time-frames.