Trendlines are a visual tool of technical analysis, which allow one to demonstrate in the simplest possible way which direction the price of a financial instrument is moving in.
The Dow theory, on which all technical analysis is based, assumes that no matter how the price behaves, it will always remain in one trend or another. If the price acts relatively smoothly and stays in the same range, without showing either growth or fall, such a trend is called a lateral trend, or a flat trend. There may be slight price fluctuations within the framework of the flat trend, according to which an experienced trader can anticipate the moment of exit from the lateral trend and transition to an increase or decrease in the value of an asset.
A series of rising maxima is typical for a growing or "bullish" trend with each new peak being higher than the previous one. Accordingly, the "bearish" downtrend demonstrates the points of failure (price minimum), each subsequent of which will be lower than the previous one.
A trendline can be constructed from two points of a minimum or a maximum, but a third confirming line is required. The more points form the trendline, the more confident and stable the trend itself. Constituent points should not be too close to each other in a temporary frame. Otherwise, the direction of the trend will not be entirely correct. Note that the line of the uptrend is built under the schedule, and the descending trend is above it.
The trendline allows to state with reasonable certainty that the price will move further in the given direction. One should also take into account the angle of inclination on the trendline as its consistency indicates the stability of the trend. The change in the angle of the trendline is called the acceleration or deceleration of price movement. The greater the angle, the more rapid the trend.
The line passing through the price minima is called the support line. As soon as the price reaches it, it finds the support of the market and rises by rebounding on it. The line connecting the price highs is the line of resistance. The level above which the value of the asset will not increase.
If the price breaks through the support or resistance line, this is an obvious signal that the trend is breaking and the tactics of trading are changing.
Trendlines are a classic instrument of technical analysis, but both bulls and bears have learned to use them in their own interests, placing traps along the way for their opponents and most of the market "crowd." These moments are characterized by a breakthrough of the support and resistance line, and then a sharp change in the trend in the opposite direction.
We will tell you in one of the upcoming materials in the series "Analyze This" about how to avoid such traps. Stay tuned for our updates.