Trends play an important role in trading, giving traders a chance to use patterns in the price data to make decisions based on more than simple rises and falls, or worse, gut instinct. But how does one identify and draw a trend on a chart?
When looking at bitcoin price charts like the one below, you can’t help notice how prices at times seem to move along invisible lines:
This can be seen whichever chart timeframe you look at, be it weekly, daily or on a 30-minute chart:
Trend lines and trend channels
The lines you see in the charts above are called ‘trend lines’. However, it is apparent that prices not only follow trend lines, they often move back and forth between two trend lines, an upper and a lower trend line:
This is then called a ‘trend channel’ and it’s probably one of the most widely used concepts in technical price analysis. One important aspect of trends is that they can be divided into shorter trend segments, which again are made of even shorter segments:
Price trends are highly fractal in nature. This mean that they appear very similar, no matter on what time frame (ie: zoom factor) you look at them.
How to draw trend lines and channels
It is fairly easy to draw trends, all you need is an interactive charting platform that allows you to draw on the charts, such as Coinstackr’s Bitcoin Charts or ZeroBlock for example. Using the ‘line’ or ‘channel’ tools, do the following:
Drawing uptrends
Uptrends generally respect the lower supporting trend line more accurately, so start the trend line at one of the trend’s lows (see [1]). Then draw the line to one of the next higher lows (see [2]). Depending on the tool used the line will automatically extend to the right and/or left:
Note how the blue moving average indicator on the chart can help you draw the line at a good angle. After drawing the line you will almost always need to move it around a bit and adjust its angle so it touches the trend’s price lows as accurately as possible. Trend lines never perfectly fit prices, however, there will always be some price candles piercing through.
Drawing downtrends
Downtrends are drawn exactly like uptrends, only that you start with the upper resisting trend line:
Advanced tip: Logarithmic charts
Exponential growth can often be seen in price charts, as shown by Bitcoin’s rally back in October and November 2013:
Exponential curves display as straight lines when plotted on a logarithmic scale. The same price series then looks like this:
Now, trend channels can be used to easily spot exponential growth. However, not all charting platforms offer logarithmic charts.
Using trends in trading
While trends can be useful, it is not advised to use them as the only factor in any entry decision. Even if prices touch the lower trend line of an uptrend and buying into bitcoin seems to make perfect sense, always look for more confirmation from other indicators (eg: other support and resistance key levels, volume analysis, price action patterns) that this trend is not going to break and losing you money.
Ideally, you want to have confluence of more than one indicator to increase the odds in favour of a profitable trade.
Furthermore, don’t forget to always look for higher and lower time frame trends. While it may seem like prices are in an uptrend on one time frame, higher time frames may reveal prices are actually in a downtrend, for instance. Many traders are not comfortable trading against the trend, which is why they rather trade true to the motto ‘the trend is your friend’.