One of the easiest ways to day trade is to use the trend line trading strategy. It only involves a few tools available within most brokerage platforms and software. This article will discuss how to draw trend lines and a few strategies that involve the use of trend lines.
Trend Lines Defined
We often identify stocks as either ranging or following a trend in the stock market. When they are ranging, then there is no clear direction. The stock price is moving up and down or back and forth on the price chart. A ranging example is below.
However, when a stock is trending, we can identify it as moving up or down. If we can identify the stock trend (uptrending or downtrending), this can be a vital tool when swing or day trading. We are all familiar with the phrase “the trend is your friend.” So, to be on the right side, follow the trend and what the rest of the herd is doing.
The drawing tool that can be used to identify a trend is the “trend line”. Trend Lines are lines drawn on a technical analysis chart that help identify movement within a stock or equity asset. They can apply to any chart timeframe (i.e., 1-minute, 15-minutes, daily, monthly).
They also can be supported across all types of markets, not just the stock market. Most traders use them as a backbone for other trading strategies and tools.
Let’s see some examples below of an uptrend and a downtrend.
Drawing Trend Lines
When a stock is uptrending, we connect the lows of at least three candlesticks. It is up to your discretion whether to include the wicks of the candlesticks. Once those lows are connected, extend the trend line to see how the stock price reacts to the trend line. We link the lows because the trend line is a point of support to continue moving the price upward. See below.
The trend line trading strategy can be used when a stock is downtrending. We connect the high of at least three candlesticks. Once these highs are connected, extend the trend line to see how the stock price reacts to the trend line. The highs are connected because they act as a form of resistance, keeping the price from moving upward. See below.
Trend Trading Tips
- Trends Change: A stock’s trend can easily change, and this may require that trend lines are adjusted or new lines are drawn.
- Trend lines are not exact: Many traders may draw their trend lines differently (with wicks or without). Using wicks is up to the trader. However, you want to capture the most price movement as support (in an uptrend) or resistance (in a downtrend).
- Trend May Differ on Multiple Timeframes: If you view the technical chart for your stock on a daily timeframe, the trend could be entirely different than on a 5-minute timeframe. In this case, the higher timeframe trend may not match the lower timeframe trend. To avoid this, many traders may decide to wait until they receive multiple confirmations from various timeframes for the trend direction to ensure they are going in the proper direction.
- Recent trend is the Most Important: If you zoom out of a stock chart, it can appear to be following one trend. However, when you zoom in to see recent prices, it can appear to be following the opposite trend. So, which direction is the trend? From experience, it is always a good idea to go with the recent price action because this is what the sellers and buyers are doing now.
Now that we have reviewed some tips on trend lines. Let’s review some simple strategies to trade trend lines.
Trading Strategy – Go With the Trend
The trend line trading strategy is one of the most straightforward trading strategies available. First, you want to draw your trend line, as discussed previously. Once this is drawn, you want to wait for the price to return to your trend line and buy the stock (or go long) once it pulls back to the trend line. For additional confirmation, you could also wait for the price to react to the trend line and close above it before buying the stock. See the example below.
In terms of a take profit level, you could allow the price to target the most recent high before taking a profit.
This same strategy also works for a downtrending market, except that once the price returns to the trend line, you would short the stock. For additional confirmation, wait for the first candle to close below the trend line.
Trading Strategy – Trend Reversal
The trend line trading strategy can also be used on reversals. To implement this strategy, draw your trend line and determine the current direction. When uptrending, wait for the price to return to the trend line and a candle to close below the line. For a downtrending market, wait for the price to return to the line and wait for a close above the line. See this example below for a downtrending market where you would go long at the spot indicated.
This particular strategy may be a little tricky as you could potentially receive some false signals. If you decide to trade this strategy, you may want to look for a quick reversal where you can get in and out of the market, as the price trend could always reverse again.
Or you want to look for additional confirmations, such as engulfing candles or extra bearish candles to signify the trend is changing. Another confirmation method is identifying the trend on higher timeframes to determine if the reversal direction matches these timeframes.
Summary: Beat the Market with the Trend Line Trading Strategy
Trading trend lines offers a simple approach to day or swing stock trading. Trend lines do not require specific indicators and are drawing tools available on most trading platforms. Therefore, they do not lag behind price, but can serve as a great way to assist in identifying the trend so that you can stay on the right side of the market.
To Learn More
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