From Support to Resistance: Using Trend Lines to Analyze Price Action
Trend lines are one of the most popular tools in technical analysis. A trend line is a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance. As the name suggests, the purpose of trend lines is to identify the overall direction of the trend. Therefore, trend lines can be ascending, descending, or sideways.
How to Construct a Trend Line
One of the biggest challenges for technical analysts is selecting points to construct the trend line.
The general rule of thumb is that the longer a low or high remains intact, the more significant it is and the more reliable the trend line built through it will be.
At least two bottoms or tops are needed to construct a trend line. When prices are rising, a line is built through the bottoms. This line will provide support for future pullbacks. In downtrends, a resistance line is built through the tops. Price increases will meet selling pressure around the downward line. When prices are ranging, the trend lines are sideways.
Ascending and Descending Trend Lines
Chart 1: Trend Lines. Source: MetaTrader4
The uptrend line on Chart 1 was broken relatively quickly. However, the downtrend line has repeatedly acted as resistance, demonstrating resilience. Each time it is unsuccessfully tested, its significance increases. Accordingly, sellers will be confident in exploiting such strong trend lines.
Horizontal Trend Lines
Chart 2: Horizontal Trend Line Support. Source: MetaTrader4
Chart 2 demonstrates buyers’ domination at specific support zone. This is often how horizontal trend lines are analyzed—as a zone (e.g., prices from 100.75 to 101.20) rather than an exact price value (e.g., 101.20). Stop-loss orders placed below the support zone are more securely protected.
Horizontal trend lines offer good trading set-ups. A beneficial reward-to-risk ratio could be attained with relatively close stops (below the lowest low in the example) and distant take-profits. This is especially true in situations like the one presented by the chart, where orders are placed in the direction of the primary trend.
Alternative Trend Lines
Chart 3: Trend line Support. Source: Investing.com
The solid red line on Chart 3 covers the uptrend in the S&P 500 Index that began at the end of the Global Financial Crisis and lasted for over a decade. The support has held back the corrective declines several times, leading to the formation of critical lows. Support lines built through such significant bottoms are considered to be solid.
Alternative trading scenarios may be developed around these stable bottoms. Each low represents the start of a new, shorter-term trend within the main one. The dotted lines demonstrate this idea. Several alternative trend lines, which form different support trajectories, originate from the 2016 bottom. Technical analysts would search for shorter-term opportunities that alternative trend lines provide.
Of course, the main trend line will offer the most significant support because it was built through critical bottoms and lasted years.
Parallel Trend Lines
Trend lines are often viewed as indicators of a trend’s slope or strength. The trend remains valid if the prices move at an acceptable deviation from the line (below or above).
Chart 4: Alternative Trend Lines. Source: MetaTrader4
Chart 4 demonstrates how the actual break of the main support line does not end the uptrend. A closely related concept to that depicted on the chart is ‘price channels,’ which we will introduce in the next chapter.
Usage of Trend Lines
Traders use trend lines to identify potential entry and exit points, such as buying near an uptrend line or selling near a downtrend line. They adjust stop-loss and take-profit orders according to trend line values.
Most traders prefer to trade in the direction of the primary trend. An intraday trader could start his analysis from the multi-year chart and reach the hourly, maybe even the one-minute chart. When long-term, mid-term, and short-term trends are in sync, the probability of success increases.
A trend line break can signal a potential reversal in the market direction.
Conclusion
The examples above illustrate fundamental methods for constructing and interpreting trend lines. Ascending and descending trend lines create dynamically changing supports and resistances, while horizontal trend lines identify pivotal price levels or zones.
Trend lines are most often used in conjunction with other technical tools.
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