What are trend lines?

In financial markets, trend lines are diagonal lines drawn on charts. They connect specific data points, making it easier for chart designers and traders to visualize price movements and identify market trends.

Trend lines are one of the most important tools in technical analysis. They are widely used in stock markets, local currencies, derivatives, and cryptocurrencies.

Trend lines basically work like support and resistance levels, but they are made of diagonal lines, not horizontal lines. Hence, it can have a positive or negative slope. In general, the steeper the line, the stronger the trend.

We can divide trend lines into two basic categories: ascending (bullish) trend lines and descending (bearish) trend lines. As the name indicates, an uptrend line is drawn from a low position to a high position on the chart. It connects two or more low points, as shown in the image below.

In contrast, a downtrend line is a line drawn from a high position to a low position on the chart. It connects two or more high points.

So, the difference between the two types of lines is the choice of points used to draw them. In an uptrend, lines are drawn using the lowest points in the chart (i.e. the bottoms of the price action chart that form higher lows). Downtrend lines, on the other hand, are drawn using the highest values ​​(i.e. the highs of the price action chart that form lower highs).

How to use trend lines

Based on the highs and lows of the chart, trend lines indicate points where the price briefly challenged the prevailing trend, tested it, and then came back with it. The line can then be extended to try to predict important levels in the future. The trend line can be tested several times, but as long as it is not broken, it is considered correct.

Although trend lines can be used in all types of data charts, they are usually applied to financial charts (based on market prices). It provides insights into market supply and demand. Uptrend lines, of course, indicate an increase in purchasing power (i.e. demand is higher than supply). As for downtrend lines, they are associated with a continuous decline in price, which indicates the opposite (i.e., supply is higher than demand).

But trading volume must also be taken into account in these analyses. For example, if price is increasing, but volume is decreasing or is relatively low, this may give the false impression of increased demand.

As mentioned, trend lines are used to identify levels of support and resistance, which are two simple technical analysis concepts, but extremely important. The uptrend line shows the support levels below which the price is unlikely to fall. In contrast, a downtrend line highlights resistance levels above which the price is unlikely to rise.

In other words, a market trend can be considered invalid when support and resistance levels break, either downward (in the case of an upward trend line) or upward (in the case of a downward trend line). Many times, when these basic levels fail to maintain the trend, the market tends to change its direction.

But technical analysis remains a subjective field, and anyone can offer a completely different way of drawing trend lines. Therefore, it may be useful to combine multiple technical analysis methods, in addition to fundamental analysis to reduce risk.

Draw correct trend lines

Technically, trend lines cannot connect any two points on a chart. But most chart designers agree that using three or more points is what makes a trend line valid. In some cases, the first two points can be used to identify a potential trend, while the third point (extending into the future) can be used to test the validity of the trend.

So, when the price touches the trend line three or more times without breaking it, it can be considered correct. Testing the trend line several times indicates that the trend may not be a mere coincidence resulting from price fluctuations.

Scale settings

In addition to choosing enough points to draw a correct trend line, it is important to consider the appropriate settings for drawing these lines. One of the most important settings for drawing charts is the scale settings.

In financial charts, the measure is related to the way the change in price is displayed. The two most famous scales are the arithmetic scale and the semi-logarithmic scale. On a chart, the change is expressed equally as the price moves up or down the y-axis. In contrast, semi-log plots express differences as a percentage.

For example, a price change from $5 to $10 will cover the same distance on the chart as a change from $120 to $125. In a semi-logarithmic chart, a 100% gain ($5 to $10) would occupy a much larger portion of the chart, unlike a 4% increase to go from $120 to $120.

It is important to keep scale settings in mind when drawing trend lines. Each type of chart may lead to different highs and lows, and thus to slightly different trend lines.

Concluding thoughts

Although trend lines are useful tools in technical analysis, they are far from foolproof. The choice of points used to draw trend lines affects the degree to which these points represent real market cycles and trends, making them somewhat subjective.

For example, some chart designers draw trend lines based on the fundamental part of the price action chart, ignoring the price volatility lines. Others prefer to draw lines according to the highs and lows of the price volatility lines.

Therefore, it is important to use trend lines in conjunction with other indicators and charting tools