Trend lines and working with them

Hello, dear traders. We continue the series of articles "Price Action trading methods". This, the second article, is devoted to trend lines as an integral part of the Price Action systems.

So what are trend lines and how do you draw them correctly?

The concept of "trend line" is often interpreted ambiguously and inconsistently. However, it should be remembered that of the many trend lines, only one is true.

Figure 1. Examples of trend lines for a novice trader.

Let's see what we see on the chart of a novice trader. Figure 1 shows such a "desktop", where we observe a lot of lines, which often cannot be called trend lines. Naturally, such constructions are based on the principle "some of them will work", which undermines the initial trust of traders to this analysis tool, but in the meantime, it is a great indicator. The main thing to remember when working with it is clear rules of construction.

Repetition is the mother of learning

To begin with, let us recall the first article of the series, or rather the answer to the question "what should be considered a trend? What is a trend?".

Figure 2. Graphical definition of a trend.

By definition, trend - is a supported movement in one direction, which is described by a very simple concept:

- An uptrend is a sequence of higher highs and higher lows;
- A downtrend is a sequence of lower highs and lower lows

Note that in an uptrend, both the lows and highs move upward. This is a common, but not mandatory, rule for a support lineswhich will be drawn through the rising lows.

Just as in a downtrend, both the lows and highs move downward. This is a common, but not mandatory, rule for a resistance line to be drawn through declining highs.

A little practice

Now let's go back to Figure 1 and see how many times the lines matched the trends... Did you do the math? That's right, it may have matched once.

Figure 3. Correctly drawing the trend line.

Now let's take a look at Figure 3. When the line is drawn correctly, it looks like this. This chart shows the movement USD/JPY. You can see how both the highs and lows declined until one day the price reversed and broke above the line and we saw a supported reversal. However, in many cases, a trendline breakout is accompanied by repeated testing of the trendline. This repeated testing gives us an excellent opportunity to open a position.

Figure 4. Test of the trend line after the breakout.

I would like to say right away that a break of a trend line is not always a trend reversal. Rather, such a breakout should be perceived as a change of trend direction, and, as we know, a trend has 3 directions - upward, downward and sideways. I will tell you when a trend line breakout increases the chances of a trend reversal in one of the next lessons.

It should be said that it is not necessary to draw a trend line from the lowest low or the highest high on the chart. Quite often, the lines that give the best signals can be drawn along what I call an "intermediate trend". An example of this situation is shown in Figure 5.

Fig. 5. Working with intermediate trends.

First, most traders will draw the line drawn here in red. It is only obvious that this line will not often be able to give us any profitable signal, so draw trend lines as soon as you see it touching the price at least three times.

Notice also how the price in Figure 5 subsequently broke above the trendline resistance and after the first upward momentum reversed to retest the trendline, giving us an excellent buying opportunity.

When a trendline is broken, retesting is very common, being a useful feature of a properly drawn trendline. A price breakout above the last downtrend peak (labeled 3 on the chart) can confirm to us that trend is over and we should wait for the rollback.

By adhering to the above guidelines, you will learn how to draw much more profitable trend lines and gain confidence that the line will give you a good chance of getting a reliable signal.

Sperandeo method

Traders draw trend lines in order to highlight the directional movement of price and to determine when the trend direction changes. It can be said that the process of drawing trend lines is subjective in nature: each trader decides for himself which minima and maxima to connect when drawing trend lines. But subjectivity is the trader's enemy. As soon as the analysis can be formalized, it becomes possible to test your approach.

In order to make the construction of trend lines more objective, you can use the step-by-step method proposed by the Victor Sperandeo.

Trend line construction

The first step in the technical evaluation of a trend is to draw a trend line. This may seem simple, but just as few people will be able to give a good definition of a trend, very few people will be able to draw a consistently accurate trend line. The method of drawing trend lines from Victor Sperandeo is based on his own trend detection, I talked about it earlier. This method leads to consistent and accurate results and almost never gives false signals.

Fig. 5. Example of trend construction by the Victor Sperandeo method.

So, the rules of trend line drawing themselves

For upward trend within the period in question, draw a line from the lowest low to the highest secondary low preceding the highest high so that the line does not cross prices between the two points of the lows. Extend the line up past the point of the highest high. The line will probably pass through prices beyond the point of the highest high. In fact, this is one of the signs of a possible trend change, but more about that in a future lesson.

For a downtrend within the period in question, draw a line from the highest high to the lowest secondary high preceding the lowest low so that the line does not cross prices between these two highs. Extend the line down past the lowest high.

The merits of this technique are that it provides an absolute means of assessing the change or possibility of a trend change. In other words, if on a chart as prices go up or down, the need to draw a trend line differently will indicate a change in trend.

Not quite clear? Let's look at a few examples...

Examples of trend construction

The following example shows examples of correct and incorrect construction of a descending trendline.

Figure 6. Correct and incorrect construction of the trend line.

The trend line drawn from point A to point B is drawn correctly, because point B corresponds to the minimum preceding the highest maximum of the movement. The trend line drawn from point A to point C is drawn incorrectly, because point C was formed later than the highest maximum. It will soon become clear why it is so important that the local maximum should precede the minimum of the price movement.

These movements can be compared to the steps of a ladder. Until the previous step is overcome, the market is still undecided about the direction of its movement, and often it enters the range between the global high (low) and the previous point support (resistances).

Conclusion

Sperandeo developed clear rules for drawing trend lines and identifying the moment of its change. His proposed method makes this element of chart analysis more objective. Of course, there are shallow retesting movements and those that lead to the formation of a real double bottom or double top, and we cannot predict in advance the depth of the pullback at retesting.