A trendline is a diagonal line that connects points serving as support or resistance. If the diagonal line connects points of support, it is called an uptrend line. If it connects points of resistance, it is called a downtrend line. Traders use trendlines to make educated guesses as to where the price will reverse.
An example trendline
From this chart, we can see that JPY/USD encountered three points of resistance from January to March, 2018. The first was hit in mid-January. The second was hit in early February. And the third was hit in late February. A diagonal line can be drawn connecting these three points. This implies that JPY/USD was in a downtrend during this time-period.
We can also see that from March to November, two major areas of support were hit. The first came in late March, while the second came in October. A diagonal line can be drawn connecting these two areas of support. This implies that JPY/USD was in an uptrend during this time-period.
Drawing a trendline
To draw a trendline, simply locate two major tops or bottoms and connect them with a diagonal line. This line should not cross the price at any point. For example, the chart below shows an incorrectly drawn trendline.
It might be tempting to draw the uptrend line this way, since it shows the price bouncing off the line four or five different times. However, this trendline is incorrect because the price passes through the line several times, instead of merely bouncing off it.
By contrast, here is another valid uptrend line that could be drawn from this chart. This could be considered an alternative to the one shown in the first image
A few points that should be kept in mind when using trendlines:
- A trendline can be drawn with only two points. But the strongest lines have at least three points to them
- The steeper a trendline is, the less reliable
- The more often a trendline is tested, the stronger it is
Once we have a trendline drawn, we can draw a channel. Channels give us even more information about a particular trend.
To draw one, simply create a line that is parallel to the uptrend or downtrend line already drawn.
As with normal trendlines, the defining lines of a channel should not cross the price. A channel that slopes upward is called an ascending channel. A channel that slopes downward is called a descending channel.
How to trade using trendlines and channels
Here are a few ways to trade using trendlines and channels:
- Buy at the bottom of a channel. Sell at the top
- Go short at the top of a channel and buy back at the bottom
- To limit risk, put a stop just above the top of a channel or just below the bottom
- Buy and hold during an uptrend. Sell when the trend breaks down
- Go short during a downtrend. Exit when the trend breaks
Trendlines are diagonal lines that connect areas of support and resistance. When combined together to make channels, trendlines can be a useful tool to find entry and exit points in trades.