Understanding Trend Lines in Technical Analysis
The use of trend lines is important for both trend identification and confirmation. A trend line is a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance. Many of the principles applicable to support and resistance levels can be applied to trend lines as well. It is important that you understand all of the concepts presented in our Support and Resistance article before continuing on.
An uptrend line has a positive slope and is formed by connecting two or more low points. The second low must be higher than the first for the line to have a positive slope.
Note that at least three points must be connected before the line is considered to be a valid trend line.
Uptrend lines act as support and indicate that net-demand (demand less supply) is increasing even as the price rises.
A rising price combined with increasing demand is very bullish and shows a strong determination on the part of the buyers. As long as prices remain above the trend line, the uptrend is considered solid and intact.
A break below the uptrend line indicates that net-demand has weakened and a change in trend could be imminent.
A downtrend line has a negative slope and is formed by connecting two or more high points.
The second high must be lower than the first for the line to have a negative slope. Note that at least three points must be connected before the line is considered to be a valid trend line.
Downtrend lines act as resistance and indicate that net-supply (supply less demand) is increasing even as the price declines.
A declining price combined with increasing supply is very bearish, and shows the strong resolve of the sellers. As long as prices remain below the downtrend line, the downtrend is solid and intact. A break above the downtrend line indicates that net-supply is decreasing and that a change of trend could be imminent.
It takes two or more points to draw a trend line. The more points used to draw the trend line, the more validity attached to the support or resistance level represented by the trend line.
It can sometimes be difficult to find more than 2 points from which to construct a trend line. Even though trend lines are an important aspect of technical analysis, it is not always possible to draw trend lines on every price chart.
Sometimes the lows or highs just don’t match up, and it is best not to force the issue.
The general rule in technical analysis is that it takes two points to draw a trend line and the third point confirms the validity.
- Trend lines can offer great insight, but, if used improperly, can also produce false signals. Other items – such as horizontal support and resistance levels or peak-and-trough analysis – should be employed to validate trend line breaks.
- Trend line breaks should not be the final arbiter, but should serve merely as a warning that a change in trend may be imminent. By using trend line breaks for warnings, investors and traders can pay closer attention to other confirming signals for a potential change in trend.