A technical analysis is the study of historical prices to help you determine where the markets might go in the future. One of the more important techniques that can be used to forecast future movements of a currency pair is drawing trend lines. A trend line describes the trajectory of a currency pair and allows you to evaluate support and resistance levels. When support and resistance levels are breached, a breakout or breakdown can occur, which might be the start of a new trend. There are many different ways to draw a trend line. Some are subjective while others are objective. A trend line is an important technical analysis tool because it can help you make trading decisions.
What is a Trend Line?
A trend line is a line that is drawn on a chart by traders to help them determine the future direction of a currency pair. Rakuten Securities Australia offers access to MT4 trading software which allows traders to draw multiple types of trend lines on many different charts. Trendlines provide a visual representation of support and resistance levels. They will help you to work out if an exchange rate is accelerating or decelerating and can provide insightful information into price patterns. There are three common types of trend line.
- Trend lines can be upward sloping
- Trend lines can be downward sloping
- Trend lines can be horizontal
How do you find a Trend Line?
Trend lines connect pivot points, which are generally the high or the low of a trading period. Trend lines work in any time frame, including daily, weekly, monthly, or even intra-day periods. The most common way to draw a trend line is when you are using a candlestick chart or a bar chart. The reason is that both of these charts provide you with an open, a high, a low, and a close. You can also draw a trend line using just a line chart, which captures just the close, but this type of trend line does not fully incorporate all the information available. A general rule for drawing trend lines is to connect two or more lows to form an upward sloping trend line, or to connect two or more highs to form a downward sloping trend line. A horizontal trend line can be created by connecting two or more highs or two or more lows. When you create a trend line, you are looking for two or more pivot points to help guide you.
Pivot Highs and Pivot Lows
While there are no hard-and-fast rules about creating a trend line, there are some objective methods that you can use as guidelines to help you draw a trend line. Your goal in creating a trend line is to determine the slope of the current market path and generate support and resistance levels. Recall that support is a level where an exchange rate finds demand and is having trouble moving lower. Resistance is a level where there is supply and is where an exchange rate finds downward price pressure.
To find a pivot high you should look for a high, surrounded by one-or-more lower highs on each side of the pivot high. To find a pivot low, you should look for a low, surrounded by one-or-more higher lows on each side of the pivot low. Once you find your pivot high and your pivot low, you can begin to draw upward sloping or downward sloping trend lines. From your pivot low, you can then look back in time for the next lower pivot low, and connect the two pivot lows to form an upward sloping trend line. From a pivot high, you can look back in time for the next higher pivot high, and then draw a downward sloping trend line.
Why is the Trend Line Important?
Trend lines are important because they can signal a change in the slope of a trend or the continuation of a trend. You can see the importance of a trend line by evaluating the trend line that was drawn on the GBP/USD which connects the lows in October of 2019 to the lows in March of 2020. When the GBP/USD exchange rate is closed below the slope of the trend line, it signals that the upward trend was broken and a breakdown occurred. This scenario differs from the trend that was in a place that was captured by the July 2020 lows which connected to the September 2020 lows. When the exchange rate tested the trend line in November 2020, it bounced and continued an upward trend. Just a few days later, the GBP/USD broke through a downward sloping trend line that was formed from the highs in August of 2020 connecting to the highs in October of 2020. Similar to upward sloping trend lines and downward sloping trend lines, a horizontal line can describe support and resistance levels. When a horizontal trend line is breached, the market can break out or break down. You can practice drawing trend lines using a forex demo account provided by Rakuten Securities Australia.
What Timeframes are Trend Lines Used In?
When you practice drawing trend lines, you can use them on several different timeframes. If you line up daily, weekly and intra-day charts on the MT4 platform, you can identify levels of support and resistance that are consistent throughout many timeframes. If you plan on day trading, you should consider using intra-day candlesticks or bars to draw trend lines. If you are planning to hold a position for several days or weeks, you might consider drawing trend lines in daily or weekly bars or candlesticks.
The Bottom Line
Trend lines are a form of technical analysis that can help you determine the slope of a trend. You can use a trend line to help you find support and resistance levels. Drawing a trend line can be subjective but you can use certain tools such as pivot highs and pivot lows to help make them more objective. Trend lines can be:
- Upward sloping
- Downward sloping
Trend lines are important because they can help you determine if a trend is likely to continue or if a breakdown or breakout has occurred.