Understanding Trendlines: A Guide to Investing
IF you’re an investor, you’ve probably heard of trendlines. But what exactly are they and how do you use them in your investing strategy? In this post, we’ll answer those questions and give you some examples to help you understand how to use trendlines.
What Is a Trendline?
A trendline is a line that traders draw on charts to connect a series of prices together or show some data’s best fit. The resulting line is then used to give the trader a good idea of the direction in which an investment’s value might move.
A trendline is a line drawn over pivot highs or under pivot lows to show the prevailing direction of price.
Trendlines are a visual representation of support and resistance in any time frame. They show direction and speed of price, and also describe patterns during periods of price contraction.
How Do You Use Trendlines?
To create a trendline, you need at least two points on a price chart. Some analysts like to use different time frames such as one minute or five minutes, while others look at daily charts or weekly charts. What makes trendlines so universal in usage and appeal is they can be used to help identify trends regardless of the time period, time frame, or interval used.
If company A is trading at $35 and moves to $40 in two days and $45 in three days, the analyst has three points to plot on a chart, starting at $35, then moving to $40, and then moving to $45.
If the analyst draws a line between all three price points, they have an upward trend. The trendline drawn has a positive slope and is therefore telling the analyst to buy in the direction of the trend. If company A’s price goes from $35 to $25, however, the trendline has a negative slope, and the analyst should sell in the direction of the trend.
The Difference Between Trendlines and Channels
More than one trendline can be applied to a chart. Traders often use a trendline connecting highs for a period as well as another to connect lows in order to create channels.
A channel adds a visual representation of both support and resistance for the time period being analyzed.
Similar to a single trendline, traders are looking for a spike or a breakout to take the price action out of the channel. They may use that breach as an exit point or an entry point depending on how they are setting up their trade.
Limitations of a Trendline
Trendlines have limitations shared by all charting tools in that they have to be readjusted as more price data comes in. A trendline will sometimes last for a long time, but eventually, the price action will deviate enough that it needs to be updated.
Moreover, traders often choose different data points to connect. For example, some traders will use the lowest lows, while others