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Trendlines
A trendline is a line which connects two nearby tops or bottoms, and is used to identify the current trends in a market. It is one of the oldest tools among traders.
The most important feature of a trendline is its angle because it identifies the force that is currently dominant in the market.
There are some important points one should remember regarding a trendline:
- Longer the time frame, the more important the trendline.
- The Longer a trendline is, the more is its validity.
- More the contacts between prices and trendline, the more valid the trendline is.
- The angle between the horizontal axis and the trendline reflects the emotional intensity of the dominant crowd.
If volume expands when prices move in the direction of a trendline, it confirms the trendline. If volume shrinks when prices pull back to a trendline, it also confirms the trendline. If volume expands when prices return to a trendline, it warns of a potential break; if volume shrinks when prices pull away from a trendline, it warns that the trendline is in danger.
The breaking of a trendline shows that a dominant crowd has lost its power.
Trading rules for trendlines:
- Trade in the direction of the slope of a trendline, i.e., buy when the slope is pointing up and vice-versa.
- A trendline provides a support or resistance level. When the prices rise, place buy orders at the uptrend line and protective orders below it. Reverse the procedure for a downtrend.
- If a trendline is steeper than 45 degrees, place a stop order right at the trendline and adjust it daily.
- Draw a channel line parallel to the trendline to use it as a target for profit-making.
- A price often retests the latest extreme after breaking a steep trendline. A pullback rally to an old high on falling volume and with indicator divergences provides a good opportunity to short sell.
Trendlines can also be applied to volumes and indicators. Rising volumes signifies that more people are getting involved in a market and vice – versa.
A trendline channel line marks the area of maximum power of bulls and max power of bears.
