What is a trendline?
Trend lines are particular lines that traders use to connect a series of prices on a chart. The investor can then use the resulting line to get a good idea of how a stock’s price might move in the future. Connecting important points of support and resistance, or important points of higher highs and lower lows, is how trendlines are made.
The trader can then use the resulting line to clearly understand where an investment might be headed.
What does the trendline show?
Before knowing how to use trendlines, You must know why we use trendlines. Technical analysts look for trends in price action rather than historical company performance or other factors. Technical analysts can determine the direction of market prices with the help of a trendline. According to technical analysts, recognizing the trend is the first stage in executing a successful trade.
A trader needs at least two points on a price chart to draw a trendline. Some analysts like to use different time frames, like one minute or five minutes. Others look at plans that are made every day or every week. Some analysts don’t care about time at all. Instead, they look at trends based on tick intervals instead of time intervals. People like trendlines because they can help them spot trends regardless of the era, time frame, or interval employed.
If the current market price of company XYZ Pvt. Ltd. is Rs 3500 and goes up to Rs 4000 in 2 days and Rs 4500 in 3 days, the analyst will need to draw three points on a chart: Rs 3500, Rs 4000, and Rs 4500. If an analyst draws a line between all 3 prices, it shows they are going up. Since the slope of the trendline is upward, the analyst knows to purchase in the direction of the trend. But if the price of company XYZ Pvt. Ltd. goes from Rs 3500 to Rs 2500, the trendline will have a negative slope, which means the analyst should sell in the direction of the trend.
Example of a trendline
Now that we know what is a trendline, let’s discuss how to use trendlines.
To draw a more accurate trendline, you should look for three consistent points of support and resistance, or higher highs and lower lows. Starting from the first point, connect the second point to the third point using a trendline. Now see the angle and pattern of the line you drew.
We can describe the market as being in an uptrend or bullish if the drawn trendline points all point upward. If, on the other hand, the drawn trendline slopes downward, the market is in a bearish or downtrend.
When a bullish candle pattern or other encouraging sign arises, a trader can buy it once it has been validated by the other trading setup tools. In the same way, if a negative candle pattern or other bearish sign appears, a trader can start selling once the other tools in his or her trading setup confirm it. Have a look at the picture for understanding.
What types of trendlines are there?
There are many different kinds of trendlines. Linear, logarithmic, polynomial, power, exponential, and moving average are some of the most popular types.
Limitations of the Trendline
It’s important to understand that trend lines have some limits, even though they can be helpful tool for analysing stock market data. Here are a few points to consider if you think you’ve found the holy grail:
1) Techniques for drawing trend lines can be different from person to person. To draw a trendline, you have to choose which price points to join, which can be a personal choice. Investors may draw alternative trendlines based on how they view the data, resulting in differing stock trend conclusions.
2) Trendlines can help identify past trends, but they may not always be accurate predictors of the future. Conditions in the market can change quickly and without warning, which makes it hard to predict trends correctly.
3) External factors may not be taken into account by trendlines. As we know, trendlines only consider price patterns and, like the price of one particular stock, they don’t care about outside factors that can affect the stock’s performance. For example, A company’s earnings, economic conditions, and international events may affect its stock price, but the trendline may not.
4) Trendlines are the best tool if you want to know if a trend is going up or down over time but can’t expect more or can’t depend on our trading on trend lines only.
5) Trendlines are all about the game of drawing a trendline; if you miss it, it can lead to a loss. Investors shouldn’t base investment decisions exclusively on trendlines, but rather on many data sources and price patterns.