Warrior Trading Blog

The Ultimate Guide to Trendlines

trendlines

Well, it’s time to talk trendlines and I’m here today to help you remove the guesswork of drawing all different types of trendlines that help you pinpoint precision entries, to help you identify trend, to signal a trend reversal. All these items can be really useful in your trading to help you maximize your profits. And today I want to show you a really powerful tool and provide you guys with the ultimate guide to establishing these high probability trendlines. So let’s take a few minutes and break down what it takes to establish high probability trendlines.

All right, what’s up guys? Time for some trendline talk here today and we’re going to talk about how to establish the highest probability trendlines. And I know that most of you are probably familiar with trendlines and you’ve probably drawn a few. But what I want to bring clarity to is that trendlines can be very subjective, in that you can draw several different lines and really not be sure which one is the right one to trade off of or what to expect once the line breaks or how to even approach a trendline that’s breaking and what to expect thereafter. So, what I’m going to do today is remove that subjectivity so that you know when you’re trading off of one of the trendlines that you will be drawing from here on out, you will be able to expect a measurable move and you can count on that line being very valid if you follow the very simple criteria that I’m going to provide you with here today.

All right, so we’re going to take a top-down approach and start with looking at the daily chart where we establish all of our major support or resistance and we’re going to work down towards our trading time frame, which is can be as fast as 15, 20 30 second charts to trade momentum. And while trendlines can be used to establish support or resistance, they also can be used to establish precision entry points. They can be established to know when to exit a trade or to stay in the trade. And I’m going to show you several examples of each, but what’s most important here today and what you use through all of that is how to establish those proper lines and what you’re going to utilize in order to create those lines.

And just starting off, what is a trendline from a very basic point of view? A trendline is simply a point of support or resistance that is on an angle. We have support or resistance that most traders are probably familiar with that are on a horizontal basis. So a recent high of something would be resistance. Okay. And that’s typically established on a horizontal basis, but a trendline follows a trend and it establishes support or resistance on an angle. So the only difference is that the support or resistance is on an angle, as you see here. Identified by my blue lines and my trendlines will always be blue. So I know the difference of when I’m looking at a chart. If I’m seeing a red line, I know it’s horizontal. If I see a trendline, I’m sorry, if I see a blue line, it’s going to be a trendline level.

So, what we’re going to talk about here today is what are we going to use to establish those lines? How do we draw them effectively? Best case scenario trendlines, some imperfect trendlines, but sometimes that does happen. Nothing is exact, especially in trading, we’re mostly working with a zone. And then obviously how to utilize these lines once they are established. So again, trendline is simply a point of support or resistance that’s on an angle. It’s going to establish either an uptrend or a downtrend, which is going to originate with swings in the market. And that’s where we’re going to start off talking about today cause that’s where we have to use to anchor the origination points of the line.

So, when we’re looking at a chart, we need to figure out where the anchor points will be for this trendline that we’re going to draw. And the way that you do that is you simply want to look left, right? Look as far left as you possibly can on chart. You can see the chart that I have up here on the screen. We’re looking back nearly 20 years worth of data here to try to find the most significant swings in the market. And the further that you can look back, the more valid your lines will become in that they have more interactions on them.

What we’re looking for here is the most significant swings in the market. So you can see, we look back 20 years, we see we have a big swing high in the market back here in early 2000. If we move forward, there’s really no other swing point in the market that is established until we get well over here in late 2015 and what I did is I use this anchor point over here, this swing high in the market and I connected it to this swing high in the market and I extended that line out to the right.

Now, what we want to do is once we extend the line out after we’ve got our two anchor points in the market is see if there’s any more interactions on the line and if that line is being respected, because that’s ultimately what we’re looking for. Is the line being respected? You can see that there definitely is another interaction with this line as we come back into it and test it right here and we actually reject off of it and pull back. But then shortly thereafter, we push above the line, we start to break out on volume. That’s a confirmation technique that if you start to break out of one of your trendlines and volume comes in, then you know that you are definitely working with a very valid trendline and you are not the only one that is working with that line.

That’s essentially going to provide you with a very measurable move, a very predictable move, and that’s what we’re looking for as traders is obviously predictable moves that create low risk opportunities and by utilizing these very valid lines, you’re going to see many of these opportunities in front of you to take advantage of.

So you can see what happens here. We have those two anchor points that we established by using the most major swing points in the market and thus we’ve created some descending resistance. Descending resistance is going to be high on the left to low on the right, so it’s going to be in a descending fashion and this is what we’ve been able to create right here. And you can see once the stock breaks up above that descending resistance or outside of the trendline, look at the type of move that you get.

A pretty impressive momentum move to the upside once that line breaks. So again, all we need to do guys is simply identify the most major swings in the market to begin anchoring our trendlines and that’s what’s going to give us the most valid points of support and resistance as far as timelines are concerned.

Now, how many touches are you looking for when you’re establishing trendline? Well, you obviously need two to establish a line, but I like to see three or more take place in order to fully validate that line and give me some confidence that “Okay, we are actually seeing a very well established trend here and I can utilize this line to trade off of if we do get an actual break.” Trendlines on the daily are often going to be very well established once you get multiple touches and this line, obviously you can see has one, two, three and then four over here before it breaks out, which is the fifth one. That’s why this one works so well because you had multiple touches and they were all major swing points in the market.

So again, very simple and straight forward. We don’t have to over complicate this as trendlines typically are. All you really need to do is look for the most major swings in the market and start connecting them. And when you start to see some consistency in reactions to the line, then you know that you have a valid line and the next time the stock interacts with that point, you should see a measurable reaction. And as day traders, we want measurable reactions. Because that’s where we’re able to make our profit from.

So if we look at the downside of things, if we look for the most major swings in the market, starting from the left and we look to the right, we can see that obviously, you know this is kind of a low down here, but if I start with this and this is going to happen, but you need to just work your way forward until you find those anchor points that you can utilize that are going to give you validated line.

So if we start down here, we can see that this would be obviously the next swing point, but that’s way out of range. So that’s not really going to provide any value to what we’re doing. So we’re going to move forward. Obviously the next most major swing low is going to be down here. So if I utilize this point here, try to make a line that has multiple touches, well that’s probably going to be somewhere in through there. But again, way out of range, not going to provide any value.

So what do we do? We continue to move forward. And you can see that’s where I got this third line from or the next line that I drew where we started to get some nice touches in through here. We had one, two, three and this was a big reaction to this line here you can see the volume that came in when you touch the line, so that’s one thing that I want to talk about here for a moment is that if you have a stock that is coming into a very major trendline that you have drawn off of major anchor points in the market or major swings in the market and you have a volume reaction to that, you can definitely count on that your line has been just that much further validated in that that level is holding.

If you see volume come in as the stock approaches a line, then that’s going to further validate your line. And that’s something that’s really important to understand when drawing your lines, because at some points in the market, you may have an anchor point that has really high volume and that is something you definitely want to incorporate into your trendline analysis. So for instance, if we had a swing high in the market that had extremely high volume, then we definitely want to incorporate that into your trendline analysis cause that’s going to be a very valid point to utilize for an anchor point.

Typically what we were looking for on the daily timeframe, as you can see here, is some sort of pattern. Trendlines will often establish some sort of pattern on the daily that we can trade off of. In this example, you can see this is essentially just a big wedge that price is contracting until we actually break through that trendline and then price expands again. So from a daily standpoint, we’re looking more on a pattern based situation here where we’re utilizing trendlines to again establish the trend and figure out where that trend is going to be breaking to look for a potential entry point that we can dial down to on our fast time frames to ultimately get into stock for a trade.

But, again, it’s very simple. It’s very straight forward. You don’t have to over complicate it and worry about drawing 20 different lines to figure out which one is the right one. Which point am I using? Which line is going to be the right line? All you have to do is start off by looking left as you do with any sort of support or resistance and from there utilize the highest or lowest swing points in the market and then just work your way back to the right, find those anchor points and then connect them and look for the consistency in the action.

Remember, minimum of three touches or more is what you want to see in order to have a valid line that you can actually trade off of. So a minimum of three touches or more. So that is looking at it from a daily standpoint. Again, we find these lines to figure out if a stock is really breaking out of trend, if it’s going to provide us a momentum tight move because the stock is either breaking down or breaking out and these provide us with really great trading opportunities because we have such precision in identifying the support or resistance.

Now one thing I do want to touch on here is that, don’t try to force a trendline. Don’t try to force a line that’s hard to identify. The most obvious is usually the best. Once you start looking at these charts on a daily basis, this type of stuff will start to just pop out at you without even having to draw a line. But, drawing a line makes it that much more clear. So just know that the most obvious points, and that’s why we’re using the most obvious points, the high swings and the low swings to establish the lines, are what is going to typically provide you with the best results.

Why? Because it’s what most others are looking at, including algorithmic systems, automated systems. They’re going to look for the highest swings and lows and they’re going to utilize those to establish trends or patterns. And once those break, that’s when you see the measurable moves take place. So remember, don’t over complicate it and try to force lines that don’t fit because you just won’t get any results after that line has been broken.

So let’s dial into a faster time frame to show you guys exactly what we’re looking for when we’re trying to establish these trendlines and what I’ll refer to the lines as on my faster time frames, refer to them as speed lines just because they’re much faster base lines and they provide us with entry signals, exit signals, establishing trend. They’re used in a much more of a day trading sense to help us identify the right points that we want to be working with when entering or exiting a trade.

So one thing to note here at the right before we get started is that trading is, it’s definitely not a science. Everything is going to be a zone. You’re rarely going to see support or resistance hold to the penny. It happens, but it’s very rare. Everything is based much more off of a zone. So don’t expect the trendlines to fit absolutely perfectly. As long as you have a zone of support or resistance established in your anchor points, then you can rely on the fact that you have a valid line.

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