Trendlines are among the most basic tools of Technical Analysis, yet are quite powerful in their interpretation.
A trendline requires at least two “touches” or price points to be drawn, similar to a ray or line in geometry. However, there are a few factors that cause some trendlines to be more “valid” than others.
1. Times Touched
A trendline that has been “tested” or touched multiple times is more valid (or significant) than one that has been tested fewer times. Trendlines gain validity each time they are successfully “tested.”
2. Angle or Slope
A trendline with a lower slope, particularly around 45 degrees, will be more valid (or significant) than one with a steeper angle. A steeper trendline will require more force to continue and is more likely to reverse.
3. Time Period
A trendline that has lasted many years is more valid than one that has lasted a few weeks or months.
Commonly Asked Questions:
“Should I trendline connect all valid points or do you allow for some points to penetrate the trendline in its construction?”
This question has inspired much debate among analysts, each having compelling arguments for both sides.
Generally, it is better to allow some “wiggle room” when drawing trendlines, particuarly using candlestick charts, and allow for intrabar penetration. Be guided by the rule “Trendlines are more valid when they are connected by more rather than fewer points.” This might mean having to draw lines that pass through some bars in favor of picking up support or resistance via other bars. Use trial and error in your analysis.
“Can I use trendlines on oscillators or other indicators?”
Absolutely! In fact, you can see signals sometimes ahead of price when you use trendlines on the RSI, On-Balance Volume, MACD, and other technical indicators. Trendlines are particularly important when looking at “Relative Strength” charts which compares one security to another.
“What is the ideal trendline?”
The ideal trendline is one which has transpired over a decent length of time, touches many price points, is not too ’steep,’ and accurately reflects support or resistance via the developing price structure.
“What happens when a trendline is broken?”
These can serve as early warning signals of a possible trend reversal ahead. At a minimum, they should give you pause that the prevailing trend might be in danger of reversing soon, though you’ll generally need further confirmation that the trend has officially reversed. The significance of the expected move depends on the above factors related to the validity of trendlines.