1.trendline in technical analysis

 Trend lines

Trend lines are amazing tools to visualize the trend and spot potential reversal points. Traders, however, usually don’t draw them properly. They try to make the market fit the line, instead of making the line fit the market. This misuse of trend lines often results in major losses for traders.

It’s easier than you think.

This article will help you understand what trends are and how to recognize them. We will then explain how to properly draw trend lines. Finally, we will see how to use trend lines, which will definitely help you become a more profitable trader.

1.  What Is A Trend And How To Recognise It

While building a comprehensive trading plan, it’s important to know about the different ways to analyze the markets. Fundamental Analysis, Technical Analysis, and Sentiment Analysis are the 3 main types of market analyses.

So what’s it all mean?

While Fundamental Analysis will help you to decide in which assets to invest, technical analysis will help you to determine when. As we will see, the concept of the trend is the cornerstone of Technical Analysis. Trend lines are therefore essential tools to correctly analyze the markets and invest in a more solid way.

Fundamental Analysis vs Technical Analysis

Fundamental Analysis is about understanding the economic forces that impact the supply/demand relationship of an asset that will cause prices to move. Technical Analysis, however, studies the effects – not the causes.

The technical approach is based on 3 premises:
Market action discounts everything, history repeats itself, and prices move in trends.

Technical Analysis will then look at past market movements to predict future prices trends.

The concept of a trend is then essential to technical analysts. They will often read charts with the sole purpose of identifying trends. They will especially focus on recognizing a trend’s early stages, so then they can trade trends while they develop. This method is called trend trading.

Trends according to the Dow’s Theory

Even though Charles Dow never published a book while he was alive, he set down several ideas about the stock market, which were published in The Wall Street Journal. Nelson, S. A. then compiled these editorials in a book called The ABC of Stock Speculation. It’s only then that the term “Dow’s Theory” was invented. It refers to several basic tenets that technical analysts use to study the markets. Let’s focus on 2 of these basic tenets here.

Market Trends

Most traders believe that the markets only evolve upward or downward. However, markets can also trade sideways. This lateral consolidation happens when market participants are undecided, which occurs about 1/3 of the time. Dow defines an uptrend as situations where prices form higher highs and higher lows. Conversely, a downward trend is defined as a pattern of falling peaks and throughs.

Each trend is also supposed to have 3 different parts: a primary trend, a secondary trend, and a minor trend. The secondary trend is a corrective movement within the primary one and lasts from 3 weeks to 3 months. The minor trend is a fluctuation within the secondary trend and usually, lasts less than 3 weeks.

The Phases Of Trends

Dow focused his work on major trends and explained that they often take place in 3 phases. First, there is the accumulation phase, followed by a public participation phase, followed lastly by a distribution phase.

The 1st phase begins with experienced traders. They will notice a stock, recognize that it’s hit bottom, and buy while it’s still good value.

The 2nd phase happens when other traders, who are perhaps less experienced, enter the markets. This is when most technical trend following analysts enter the markets. Usually, market prices will accelerate and the news will be more positive about a given financial asset.

The last stage takes place when the news is extremely positive and bullish on this asset. The same traders that went bullish on the asset while no one wanted to buy it now start to sell it before anyone else.

2.  What Are Trend Lines And How To Draw Them

Trend lines will help you to spot areas on a chart where the supply/demand for a given asset has increased.

The above chart shows first an uptrend line on the EUR/USD currency pair. The uptrend line has a positive slope connecting low points, with multiple connected points ascending upwards. Uptrend lines play the support role – as long as prices are above them, the bullish trend is intact.

To sum up:

A trend line is a straight line that connects several points on a chart, which can be used to both establish trends, and to forecast the future direction of a given asset, with trend lines acting as a support/resistance lines. The trend lines show zones where the forces of supply and demand meet and push prices to move.

A support level is a level where the demand for an asset is stronger than the selling pressure, preventing prices from falling further.Conversely, a resistance level is a threshold at which selling pressure is greater than buying pressure.

How To Correctly Draw Trend Lines

If there is an uptrend, the 1st thing to do is to draw an ascending support trend line. Conversely, if there is a downtrend, you should draw a descending resistance line. If you draw an ascending resistance trend line with an upward trend, you won’t get any relevant information. You can only see a potential change in the current trend with an ascending support line. This line will indicate that the previous bullish movement is no longer valid.

Here are other important criteria to take into consideration when using trend lines.

• Time frames – Higher time frames will always produce the most reliable trend lines.
• Validation – In geometry, you need 2 points to draw a line. In Technical Analysis, you need 3 points to draw a trend line. The more points touching the line, the more solid and valid the line will be.
• The spacing of points – The points used to draw the trend line shouldn’t be too close or too far away from each other.
• Overlap – Highs and lows from candles will sometimes overlap with the trend line, but it’s important to have the bodies of candles touching the trend line.
• Psychological Reaction on the Line – The points of contact should always trigger a price reaction. A psychological reaction from market participants should then always happen in contact with the line.
• Angles – The steeper the trend line, the weaker its validity will be. A very steep trend line usually shows a sharp price advance/decline, which will not offer meaningful support/resistance levels.
• 3.Using Trend Lines To Make Profitable Trades

• On the below chart, you can see that the price had followed the ascending support trend line for a number of years. Every time prices touched the trend line, you could have reliably opened a long position and traded with the trend. Trend lines are also useful tools to detect potential reversal points.

  

  After an upward acceleration, prices eventually lost momentum: the highs and lows became lower and lower. Once prices broke the trend line with a long red candle (bearish marubozu), they retested the former support. This level then became a new resistance level, as highlighted in the rectangle of the same chart. This is called a pullback. This retest gave you a perfect selling trading opportunity to make profits.

  As you now understand, trend lines are useful trading tools to implement in your investment strategy, as they can help you to make more profitable trades. When prices touch a trend line, it gives you an opportunity to enter the markets with the main trend. When price breaks a trend line it is usually with higher trading volume. Potential buying or selling trading opportunities will appear once a trend line is retested after being broken.

2.Continuation patterns

Continuation patterns can present favorable entry levels to trade in the direction of the prevailing trend. Keep reading to find out more about trading with continuation patterns, and the best bearish and bullish formations to include in your technical analysis.

WHAT ARE CONTINUATION PATTERNS?

Continuation Patterns are recognizable chart patterns that signify a period of temporary consolidation before continuing in the direction of the original trend. Consolidation appears in the form of sideways price movement. The pattern completes itself upon a strong breakout of the consolidation zone, resulting in the continuation of the preceding trend. Continuation patterns usually play out over the short to intermediate term.

BULLISH CONTINUATION PATTERNS

Bullish continuation patterns appear midway through an uptrend and are easily identifiable. The main bullish continuation patterns are introduced below.

1. Ascending triangle

An ascending triangle pattern is a consolidation pattern that occurs mid-trend and usually signals a continuation of the existing trend. The pattern is formed by drawing two converging trendlines (flat upper trendline and rising lower trendline), as price temporarily moves in a sideways direction. Traders look for a subsequent breakout, in the direction of the preceding trend, as a cue to enter a trade.

2. Bullish Pennant

A bullish Pennant pattern is a continuation chart pattern that appears after a security experiences a large, sudden upward movement. It develops during a period of brief consolidation, before price continues to move in the direction of the trend with the same initial momentum.

The triangular pattern is called a Pennant, which is made up of numerous forex candlesticks and is not to be confused with the larger, symmetrical triangle pattern.

3. Bullish Flag

The bullish flag pattern is a great pattern for traders to master. Explosive moves are often associated with the bull flag as it provides a temporary respite to a sharp initial move. The bull flag and pennant pattern appear under the same conditions (sharp and sudden move in price) however the bull flag can offer more attractive entry levels.

The bull flagis characterized by a downward sloping channel denoted by two parallel trendlines against the preceding trend.

4. Bullish Rectangle pattern

The rectangle pattern characterizes a pause in trend whereby price moves sideways between a parallel support and resistance zone. The pattern indicates a consolidation in price before continuing in the original direction of the existing trend. The added benefit of this pattern is that traders have the opportunity to trade within the range or trade the eventual breakout, or both.

BEARISH CONTINUATION CANDLESTICK PATTERNS

Bearish continuation patterns appear midway through a downtrend and are easily identifiable. The bearish versions of the similar patterns introduced above have the same impact but in the opposite direction. The main bearish continuation patterns are introduced below.

1. Descending Triangle

The descending triangle pattern is a consolidation pattern that occurs mid-trend and usually signals a continuation of the existing downtrend. The pattern is formed by drawing two converging trendlines (descending upper trendline and flat lower trendline), as price temporarily moves in a sideways direction. Traders look for a subsequent breakout, in the direction of the preceding trend, as a milestone to enter a trade.

2. Bearish Pennant

The bearish pennant is a continuation chart pattern that appears after a security experiences a large, sudden drop. It develops during a period of brief consolidation, before price continues lower, in the direction of the prevailing trend.

3. Bearish flag

Just like the bullish flag, the bearish flag is often associated with explosive moves before and after the appearance of the flag.

The bear flagis characterized by an upward sloping channel denoted by two parallel trendlines slanting against the preceding trend.The flag is not to be confused with the rectangle pattern. The flag is completed in a much shorter time period (one to three weeks) compared to the rectangle pattern and has a noticeable gradient.

4.Bearish Rectangle

The bearish rectangle pattern characterizes a pause in trend whereby price moves sideways between a parallel support and resistance zone. The pattern indicates a consolidation in price before continuing in the original direction of the existing trend. Traders have the opportunity to trade within the range or trade the eventual breakout, or both.

TRADING CONTINUATION PATTERNS

Continuation patterns tend to be goodindicators of future price movement,provided traders adhere to the following tips:

1. Identify the direction of the trend before price starts to consolidate.
2. Make use of trendlines to identify which continuation pattern may be developing.
3. After successfully identifying the continuation pattern, set appropriate stops and limits while adhering to a positive risk to reward ratio.
4. Traders can wait for a strong breakout in the direction of the trend before entering. Furthermore, traders should consider placing a tight stop to protect from a false breakout and trail this stop if the market moves favorably. Consider this and other risk management strategies to employ.

  

3.reversal patterns

 A price pattern that signals a change in the prevailing trend is known as a reversal pattern. These patterns signify periods where either the bulls or the bears have run out of steam. The established trend will pause and then head in a new direction as new energy emerges from the other side (bull or bear).

For example, an uptrend supported by enthusiasm from the bulls can pause, signifying even pressure from both the bulls and bears, then eventually giving way to the bears. This results in a change in trend to the downside.

When price reverses after a pause, the price pattern is known as a reversal pattern. Examples of common reversal patterns include.

1.Head and shoulder

On the technical analysis chart, the Head and shoulders formation occurs when a market trend is in the process of reversal either from a bullish or bearish trend; a characteristic pattern takes shape and is recognized as reversal formation.

2.Head and shoulders bottom

This formation is simply the inverse of a Head and Shoulders Top and often indicates a change in the trend and market sentiment. The formation is upside down and the volume pattern is different from a Head and Shoulder Top. Prices move up from first low with increase volume up to a level to complete the left shoulder formation and then fall down to a new low. A recovery move follows that is marked by somewhat more volume than seen before to complete the head formation. A corrective reaction on low volume occurs to start formation of the right shoulder and then a sharp move up due to heavier volume again breaks though the neckline.

Another difference between the Head and Shoulders Top and Bottom is that the Top Formations are completed in a few weeks, whereas a Major Bottom (left, right shoulder or the head) usually takes longer, and as observed, may be prolonged for a period of several months or sometimes even more than a year.

**importance of neckline

The neckline drawn on the pattern represents a support level, it cannot be assumed that a Head and Shoulder formation is complete unless the support level is broken. Such breakthrough may happen to be on greater volume or may not. Breakthroughs should be observed with great care. Serious drops can occur if a breakthrough is more than three to four percent.

When a stock drifts through the neckline on small volume, there may also be a wave up in some cases, although it has been observed that such a rally normally will not cross the general level of the neckline before selling pressure increases and a steep decline occurs, after which prices may due to greater volume.

3.double top

The double top is a frequent price formation at the end of a bull market. It appears as two consecutive peaks of approximately the same price on a price-versus-time chart of a market. The two peaks are separated by a minimum in price, a valley. The price level of this minimum is called the neck line of the formation. The formation is completed and confirmed when the price falls below the neck line, indicating that further price decline is imminent or highly likely.

The double top pattern shows that demand is outpacing supply (buyers predominate) up to the first top, causing prices to rise. The supply-demand balance then reverses; supply outpaces demand (sellers predominate), causing prices to fall. After a price valley, buyers again predominate and prices rise. If traders see that prices are not pushing past their level at the first top, sellers may again prevail, lowering prices and causing a double top to form. It is generally regarded as a bearish signal if prices drop below the neck line.

The time between the two peaks is also a determining factor for the existence of a double top pattern. If the tops appear at the same level but are very close in time, then the probability is high that they are part of the consolidation and the trend will resume.

Volume is another indicator for interpreting this formation. Price reaches the first peak on increased volume then falls down the valley with low volume. Another attempt on the rally up to the second peak should be on a lower volume.

4.double bottom

A double bottom is the end formation in a declining market. It is identical to the double top, except for the inverse relationship in price. The pattern is formed by two price minima separated by local peak defining the neck line. The formation is completed and confirmed when the price rises above the neck line, indicating that further price rise is imminent or highly likely.

Most of the rules that are associated with double top formation also apply to the double bottom pattern. Volume should show a marked increase on the rally up while prices are flat at the second bottom

 

5.triple top

Triple top is a trend reversal pattern that depicts buying weakness and a failure to absorb selling pressure, resulting in a sell-off. This chart pattern depicts three distinct peaks, called resistance, inside a price zone that the stock price has failed to conquer. As the price gradually starts showing weakness, and eventually breaks the lower reversal levels, called the support, the asset is said to have a triple top breakdown.

How to trade Triple Top

If the price makes three distinct attempts to conquer the selling pressure at a certain level or a range, and fails to do so, the price is witnessing diminishing strength. The pattern thus formed is called 'Triple Top'. These three distinct peaks indicate resistance which becomes the stop loss for a downtrend rally.

One can keep the stop loss level slightly above the resistance point. As we go further and the price breaks down on the immediate support, the target is identified as the difference of resistance line and the support line. If the price fails to rebound around the difference value, then the next downside may see a severe sell-off.

Sometimes the price makes wild swings during intra-day sessions, showing a breakout; however, one should wait for a decisive close.

6.triple bottom

As the name suggests, a triple bottom chart has three lows and it signals a reversal of the prevailing downtrend. A triple bottom stock pattern can be formed on a line, bar or a candlestick chart. It is a bullish reversal pattern and is formed after a considerable downward price trend.

The first bottom is formed when the price of the security declines but bounces back from a specific level. The sellers are in control of the market, but are unable to take the price below the support level. The bulls take over at the support level and take the price starts rising but faces resistance at a level.  The bulls are not able to take the price over the breakout point.

At the price touches the resistance, the bears take control and drive down the price towards the support level but are again unable to take it below the support level. The second bottom is formed. The bulls take over from there and drive the price higher. After a point, however, the bears become dominant and drive down the price to the support level. The bears fail for the third time to drive the price below the support level, forming the third bottom. On the chart, a triple bottom pattern looks like a classical zigzag pattern.

How to trade

The triple bottom chart pattern is a reliable pattern but it is not advisable to take action without additional conformation signals. Traders should look at indicators like relative strength index and if the stock has an oversold index, one should enter the trade. If the stock has an oversold relative strength index before the triple bottom is formed and the price crosses the breakout levels, one could take long positions..

Gaps

Gaps occur when there is empty space between two trading periods that’s caused by a significant increase or decrease in price. For example, a stock might close at $5.00 and open at $7.00 after positive earnings or other news.

There are three main types of gaps: Breakaway gaps, runaway gaps, and exhaustion gaps. Breakaway gaps form at the start of a trend, runaway gaps form during the middle of a trend, and exhaustion gaps for near the end of the trend.

A gap is a capital market term, used to describe discontinuation in a price chart caused due to change in market fundamentals when the market is closed. If the price of an asset significantly rises or falls from the previous day’s closing without any trade taking place in between, a gap occurs. It can occur due to significant market news to sway investors’ sentiment either positively or negatively like, earning calls after-hours.

Gaps are common occurrences, but not all of them are of equal significance. Experienced traders know which gaps to take note of and which to ignore. Mainly, gaps in stock market are categorized into four types. Check them out below.

Types of gaps

Gaps are easy to spot but determining its importance and interpreting it is what needs knowledge and practice. Here are the four types of gaps that occur in a price line.

Common gaps

Common gaps are also called trading gaps or area gaps. Usually caused by regular market forces and don’t require a special event. As the name suggests, these are common occurrences and non-eventful. So, these also get filled up as quickly, meaning the market retrace after a few days or weeks to its original level.

In a price chart, a common gap appears as a non-linear jump or drop from one point to the next.

How will you identify a common gap? There is no significant market news that can cause a market rally, and these gaps are usually smaller in size. Common gaps get filled up as fast as they appear.

Breakaway gaps:

It occurs when the price tries to break away from the congestion area.  To understand breakaway gaps better, we must understand what congestion area is. Congestion area refers to the price range in the market where the trading is happening for a while. The highest point in the congestion is usually called the resistance when approached from below. Similarly, the lowest point, when approached from above, refers to as the support level.  A breakaway gap occurs when the market breaks out of the resistance or support barrier. It needs market enthusiasm to cause a switch in trend. That is, either too many buyers for upward movement or sellers for the downtrend swing.

When a breakaway gap occurs volume of the stock should also pick up, preferably after the gap happens to conform the direction change. A new support level is created where the market breaks out. Conversely, the new resistance level is adjusted where the trend breaks downward. Breakaway gaps, unlike common gaps, when appears, usually take a longer time to fill up.

A good breakaway gap happens when it is associated with the classical price chart.

Runaway gaps

Runaway gaps can happen in both uptrend and downtrend, it usually is a representation of a sudden change in interest or perception about a stock among traders, accompanied by a shift in demand to spike buying or selling.

Runaway gap, when associated with an uptrend indicates a change in traders’ interest in the stock. Traders, who might have missed the previous uptrend may go for a frenzied buying spree after realizing that a retracement might not happen. This cause the trade volume and price to shoot up suddenly and significantly.

Similarly, a runaway gap in a downtrend is a representation of excess liquidity in the market.  It may lead to a downward spiral. Seller may panic and sell the stocks, which might cause the stock price to dive lower.

Traders use a concept of measuring the gap to decide how long the trend will continue. It usually happens in the middle of a trend.

Exhaustion gap

As the name suggests, it occurs at the end of a prolonged uptrend or downtrend, indicating a trend change. It is often associated with a rise in price along with an increase in volume. Exhaustion gaps can be mistaken for runaway gaps. To distinguish between the two, traders compare both price and quantity. If both price and volume increase, it is called an exhaustion gap.

Check out the chart below. Notice that the price rise is accompanied by an increase in volume, which is why it is an exhaustion gap.

Conclusions

To trade efficiently, traders should be able to identify and interpret gaps correctly. Even though they are common in daily trade charts, they aren’t free from limitations. A critical concept that associates with gaps is ‘filling’. It is a concept where market readjusts to the price level nullifying the sudden change caused by the gap.

Failing to identify a gap or reacting to it may cause one to miss an opportunity to exit or enter a market, which means it weighs heavily on profit or loss from a trade.

4.The bottom line

Price patterns are often found when price "takes a break," signifying areas of consolidation that can result in a continuation or reversal of the prevailing trend. Trendlines are important in identifying these price patterns that can appear in formations such as flags, pennants and double tops.

Volume plays a role in these patterns, often declining during the pattern's formation, and increasing as price breaks out of the pattern. Technical analysts look for price patterns to forecast future price behavior, including trend continuations and reversals.