Trendline refers to a line drawn over pivot highs or under pivot lows to show the prevailing direction of price.
In technical analysis, a trendline refers to a line drawn over pivot highs or under pivot lows to show the prevailing direction of price. Trend lines are a visual representation of support and resistance in any timeframe. They portray the direction and speed of price movement and also visualize patterns during periods of price contraction.
How to draw a Trendline?
In order to draw a trend line, a trader must identify at least two points on a price chart, to put it differently, one has to first identify two major picks or bottoms and then connect them. Thus, It takes at least two tops or bottoms in order to conclude a trend line exists, but it takes THREE to confirm a trend line. In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys). In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).
If drawn correctly they can be very useful in identifying the price direction. Just like the support and resistance explained in the previous topic, once the market reaches a valid trend line it could either respect it and bounce back or violate it and breakthrough it.
The steeper the drawn trend line, the higher the chance for the market to violate it and breakthrough it.
The more often the market tests a trend line and respects it, the stronger that trend line is.
In the USD/CAD chart below, notice the price is moving in form of a channel and has touched the upper and lower trendlines more than five times. As you can see, once the price reaches either trendline, it changes its direction almost immediately. This is due to the fact that the upper trendline is serving as a dynamic resistance level that traders are watching and the lower trendline is serving as a dynamic support level.
Another example is the AUD/USD chart below. As you can see, we have a very strong trendline that the price has touched it around six times, and right after each touch, the price has bounced back and failed to break. This creates a great opportunity to sell once the price approaches near the trendline.
Moreover, notice that in the end, the price has finally violated the trendline. Prior to the violation, the trendline was serving as a strong dynamic resistance level that the price was unable to break through it, but now since the price was able to pass through it the trendline reverses its role and will serve as a dynamic support level.
Most traders make this mistake and forget about the trendline once it is violated. It is important to note, that just like support and resistance level, the trendline also reverses its role once violated. In the chart above, you can see after the violation, the price has retraced and touched the upper part of the trendline.
In the end, a trendline is a graphic way of displaying the underlying trend, that helps to identify the dynamic levels of support/resistance in the market. Traders should not ignore the importance and effectiveness of trendlines in technical analysis. Using trendlines together with other technical tools can generate high quality trade setups.