Trend line is a line which indicates the trend of the market and it can be drawn crossways between (Minimum 2) two or more points by joining low with a low, or high with a high of the price data either on candle stick chart or on an OHLC chart. Trend line is an important tool for the identification or the confirmation of trend to judge the entry or exit decision. It can be drawn on any equity market, commodity or any market we are trading on. This trend line concept is very old and people have been using this as to identify the trend of a stock or commodity. Now the application is used in any kind of financial market.

Trend lines can be drawn on any time frame viz. daily, weekly, 5 min, 2min, 60 min etc. It actually depends on the need of a trader which time frame he is working on and how long he wants to hold the trade. We can draw many trend lines originating from a single point. The difference in that trend line would be of slope. Some trend lines are steep, some are slightly tilted. It all depends on the trader which two points he is connecting. In simple words, generally we take series of swing high or swing low to for a trend line. As we have discussed, we have to join low with low or high with high to form a trend line.

An Example of a trend line

The idea behind using this trend is to identify the price movement behavior in the stock as how the stock is moving whether it is moving very fast or it is moving with gradual pace. Trend lines are of two types which we call as upper trend line and downward trend line. The idea of trend line study starts with Andrew Pitch Fork’s revolutionary theory on the trend line. This theory is a mile stone in the history of Technical Analysis. It helps in identifying Trading or Trending market. It is one the best and simplest tool to apply in market. It is used to identify support and resistance.

Andrews Pitchfork Theory

A very famous TA Dr. Alan Andrews has devised a trend line and channel trading concept to help the traders to identify the areas of support and resistance of any rally short term or medium term from baseline. This application of the median line is very important when we use this Andrews Pitchfork tool. It gives an idea of buying the stock near lows which acts as support and selling them when they come near high or resistance level. These lows and highs are identified by the channel line of the pitchfork. The basic idea is to trade the channel in between from one level of support or resistance to the next.

E.g. :-  A stock price starts from a point A, goes up to a point and reverses back from there. We mark that point as B, and we sell from that point B to the next swing point which we mark as point C.  We have to draw this formation by starting the line from point A (the starting point of the stock movement) and extend that towards the point B and drag it towards C, and then the line started from the point A gets divided into two parts equally. This can be drawn with the help of charting tool called Andrew’s Pitchfork.

Andrews pitchfork works as a channel trend line in which we have to take swing high and swing low of any particular swing side movement. We have to take a swing and mark the low and draw a line to its high from its low to high of that swing and then from that High we have draw a line to its lowest point of next swing.

In the chart, we have marked the starting of the first swing as A and the high of that swing is marked as B. and from there on to next swing lowest point we have market it as C.

So the formation is basically an ABC pattern of two swings.

We will choose

  1. Low high and low
  2. High Low and High

An Example of Andrews Pitchfork Tool

 

Channel

Channel is a separate path through which price flows in some direction either upwards or downwards. Channel is the range of prices connecting a security’s resistance level and support level.  They are two parallel lines which are formed by joining Higher Highs and Higher Lows or Lower highs and Lower lows

In an uptrend channel formation we will observe series of new high along with series of new higher lows. As we know technical analysis is not absolute and it very subjective. Many people use trend lines and channel as a way of gauging the trend or the direction of the movement. The purpose of the channel and trend line is to identify the direction of the trend in a stock.

  1. Uptrend
  2. Downtrend
  3. Sideways

 

Traders often use them as to find out the support and resistance level for making some trade decision. They do act as support and resistance and on the basis of it trading on this formation. The reliability of this trend line and channels is little compromised but then we said it is more of a subjective. Since we draw the formation on the basis of historical data and future projection on them many times prove bit inaccurate or incomplete.

 

Plotting Trend line/Channel

Trend line and channels are formed by joining high to high and low with low.  A trend line is simply a momentum indicator. Many times what happens is candles violate the trend line or channel by piercing those support and resistance line which raises the confusion in the mind of traders. So to avoid those little snags we generally look for candle closing. If the price has given candle closing then we assume that trend is shifting its gear and may reverse any time. But again this also is not 100 percent fool proof.

Trading Channels

 

There are two ways of trading on the basis of channel.

  1. Trading inside Channel
  2. Trading on Channel Breakout

 

Channel Range Trading

  1. Trading inside the channel means whenever we see two swing high and two swing low in a uptrend then we should buy at lower time when price comes again the third time near the lower trend line or support line. In this case our target would be the upper level of the channel or upper trend line In this case our stop loss would be, if price gives two continuous closing below the lower trend line then we have to exit of our long or buy trade.

Same way we can make short sell position i.e. selling the stock near upper trend line and keeping the stop loss on closing basis above the upper trend line with a target objective towards lower trend line.

Channel Breakout

  1. When channel is formed with two points of swing high and two points of swing low, we have to wait for the price to give closing either above the upper trend line or below the lower trend line. Whichever side price breaks the trend line first, we have go for that side of trade. If it breaks the lower trend line on closing basis we have to go for short sell and if it breaks the upper trend line on closing basis we have to go for long side trade.

Stop loss in this case would be the 10% of target. Target here we can calculate by measuring the perpendicular height between the upper trend line and lower trend line near the breakout point level.

Trend lines and channels is just a way to trap the range of the price movement. It is usually used for short term trading and specifically the trend line is used for intraday trading. Trading with an objective for long term becomes bit risky. Because at times what happens is that price despite after breaking the upper or lower trend line, they don’t change their course. They just slow down their movement pace and keep on continuing in that direction.

Few Examples

 

Key Points to remember

  1. Trend lines can be drawn through the price lows in up-trend – and through the highs in a down-trend.
  2. People also draw trend lines on candle closing basis but candle closing basis is ideally used for long term trend.
  3. One can use and make charts on either linear scale or log scale charts but trader must be aware of their respective weaknesses.
  4. Trend lines must be respected by at least by 2 points of swing low for or 2 points of swing high in an uptrend and as well as in down-trend. Swings shape very often is like U, V or inverted U, V.
  5. Channels should not overlap price at any point if extended.
  6. Trend lines and channels can be used on any time frame and aptly be applied of intraday trading and Positional trading.
  7. Working alone on the basis of trend line is risky, should be used along with different technical tools.
  8. Steeper the trend line the severe and quickly it breaks and fall.
  9. Many trend lines can originate from a single point and they just reflect the rate at which price is moving.