Technical analysis involves the evaluation of past price actions to predict future actions. Using tools, indicators, and oscillators, traders identify potentially significant data from a particular period or periods of the market’s past movements; then use the resulting information to make calls on future movements and place their trades accordingly. Understanding this basis, one can know how important these tools are to traders, and which ones are given priority over the others. One of the most basic, and yet one of the most important tools to a technical analyst is a trendline.
A trendline is a line that typically connects two data points on a chart. It basically exists to show the best fit of some data in the market. The data points are primarily price data, but trendlines can also be drawn in technical indicators and oscillators.
Before a trendline can be plotted, the trader must identify the two data points he wants to connect on the chart, usually within a specific timeframe. The tool then plots out a line or a curve between the selected points. Timeframes for trendlines could be minutes, hours, days, weeks, and ranging all the way down to years. However, they are generally more reliable over longer timeframes. Trendlines can also be plotted over ticks rather than timeframes, depending on the need of the analyst. There can be multiple trendlines plotted over a single chart as well, with each revealing different information such as support and resistance when plotted over pivotal highs or pivotal lows in the price history of the market to form what is called a channel. The more the prices touch the trendline, the stronger the line is. Generally, it is believed the candlesticks must touch the trendline at least three times for it to be valid.
Trendlines have a solid arsenal of uses. The primary use of trendlines is to determine the trend of the market. Plotting a trendline forming a downward slope is a typical pointer of a downtrend, and the trendline is negative. The opposite is a positive trendline, which is plotted as an upward slope up the chart to reflect an uptrend. It is, however, noteworthy once more that this is reliant on the timeframe over which it is being measured, and it becomes stronger over longer timeframes. Trendlines are generally used to visualize certain aspects of price action to identify overall trends and market structure, giving the traders a deeper understanding of the market. Some traders take it a step further, using trendlines for more than just understanding but also for creating actionable trading ideas. This is based on the importance of trends as a friend of traders. So an upward slope could mean to buy in the direction of the trend, while a downward slope could mean to sell. Trendlines could also be used to identify price patterns in areas of concentration rather than rapid movement.
The main advantage of trendlines is that they help to identify trends as well as any other technical indicator, no matter what the timeframe or time period is; which is the foundation for making good trades. However, they need to be readjusted often to keep up with the incoming data. Also, trendlines over smaller timeframes are less reliable due to volume sensitivity and spontaneous market movements.