All About The Trendline.

16 jun 2021

Hi,

Trendlines: if you do not have any rules to draw the trendline (TL) then this is the most subjective technical analysis criterion of all.

Without any rules, you can draw it basically as you want to see it. It is a perfect criterion to talk yourself into the trade or to talk to stay in the bad trade, always there is a new "support" coming. If you do not have any rules to draw it then basically all the time you can find some dots to connect which can seems "perfect" for you.
In this post, I'll talk about buying opportunities from the trendline analyzing crypto and stocks. Some rules to draw it and some typical mistakes you should avoid.

Let's start from the basics. Obviously, you know that to draw a trendline we have to connect two points and waiting for the third one to reject from it. Easy yes!? NB: For me, the third and the fourth touch are the most reliable touches to wait for. The strongest trendline comes from the points which are easily recognizable - a blink of an eye.

If you start looking deeply from where to draw a trendline then keep in mind that it is not the strongest! One second and you will know from where I should draw it!

There are some "experts" who say: you cannot draw a trendline without three touching points. Phh...as you see on the image above, I can, and as said if I have a correct lineup the third touching point is the strongest.

The second myth for me: the more touches you have on the trendline the stronger it is. Yes, the trend is probably stronger, but for me, every next touch increases the odds for a break/trend change.
Sure, I have done great trades from fifth or form the seventh touch but in general, the criteria crossing area has to be quite strong and it has to consists of many strong criteria to do that.

Why I don't like to trade for example fifth or sixth touch? Firstly, the trend is your friend until its end. The market moves up and down, as said the more touching points you have, the odds will go higher for the trend change.
Think like that, basically TL works as a support and the support is hmm...like the 5cm ice on the lake. You cannot break it with one hit, you cannot break it with second or third (ok If you are strong then you can :P). Fourth, fifth it starts to crack, and the sixth...booom...you are in the water. I don't know was it a good parallel but for me, it works the best - the more touches you have the lower chance for sustainable further growth it is.


RULE nr. 1
It is true, that you can draw it in many many ways but let's talk about the first rule. If there aren't any anomalies then the trendline should be drawn "always" from wick to wick (image above) or from body to body. "Always" because there are some cases from where you should draw a bit wider trendline but in general it should be like the prementioned rule.

If you start from the wick and the second point is from the body then this is a mistake. The mistake can lead you into quite an ugly trade/investment. If you trade breakouts then it will be misleading for you, if you trade rejections from TL then it will put you in a thought situation - do I should close it if it falls lower or whatever, simply don't do it.
If you don't have any significant large wicks then go from wicks. Usually, it will give you the most precise price zones from where to grab something. If you can draw the trendline but one touching point consists of large/huge wick (selling panic or whatever it was) but on other hand, it is quite a normal price action then use candle bodies to draw the trendline. This panic-wick can mislead you. Drawing from the bodies just widening the buying area a bit but still, it gives you a good zone to keep an eye on.

If there are a lot of wicks, then there is also a good way to go with a line chart instead candlestick.

Candlestick chart

Line chart
As you see the line chart removes the market noise and you can simply see the closing prices. I use it quite a lot because some altcoins or stocks are quite jumpy and to remove the noise I use a line chart to determine the strongest areas. Stora Enso Idea

Let's jump into rule number two. If we will wait for that third touch then there are quite a lot of small rules to keep an eye on. We want to be perfect so let's find a perfect trendline.


RULE nr. 2
It increases the odds of rejection from TL if the price has made a new higher high (HH) after the previous rejection.

As you see, after the third touch of the trendline, the price has made a new HH and the fourth worked perfectly.

- two touching points, we can draw the trendline, waiting for the third touch and if it comes the market has made a new HH after the second touch and we are ready to take it.

Summary: After the price prints the second point from where to draw the trendline we have to see a new higher highs formation after every touch. This is a great sign that the trend is strong and if everything lines up perfectly we can step in.


RULE nr. 3
It increases the odds of rejection from TL if the touching point timings/length are pretty much equal.

After the price has printed a new higher high and coming back down to make the third one it is great to see symmetric between touching points. At the moment, we have a great symmetric and trendline as a criterion is in place! This simple rule shows you that the market is healthy, moves on decent cycles as it should be, no pumps, no dumps just a simple and clean one.

The second example:

As you see gaps are quite similar and the 4th touch worked almost perfectly. Waited for rejection and stepped in after I saw a decent volume from the trendline.

They cannot be the embarrassingly accurate length, otherwise, they would be extremely few, but they cannot be as in the picture below.

Uuuh...this is ugly and actually, I see it quite often. The first and second points are too-too close considering the third touch. The third touch comes in the middle of nowhere but as said, it is a perfect way to talk you into the trade/investment. This is ugly, it is with a very low success rate so try to avoid it.

The most important rules are in place and now it's a good time to talk about mistakes. I cannot say that they are 100% wrong but in general, these mistakes can be with a very low hit rate.

Sometimes looks like we have all set and ready. We can draw perfectly from wick to wick, we have new higher highs after touches, we have an equal length between touching points but it just doesn't work. Obviously, from time to time it happens but most of the time there are some reasons behind that and one of them can be the angle of the trendline.
It is a bit subjective but for me, the best angle of the trendline stays between +-20 to +-35 degrees (in TradingView you can use it). Then I can trust it the most. I remember that the most common mistake for me I tried to buy too sharp angles 45+ degrees. To long below 20 or above 35 degrees you should have a lot of criteria to match with the trendline to determine the strong setup otherways try to be cautious if it doesn't fit inside my given numbers.

Next common mistakes:

As you see in the image above, after the third touch, we haven't seen a new higher high but the price already touching the trendline. It isn't a good sign for further growth. Does the bulls have lost their momentum or for whatever reasons the market didn't print the new higher high. This can be simply one of the trend reversal signs, bulls have lost their momentum and cannot print new ATH for example. Read between the lines and do not consider buying from the trendline if the market hasn't made a new higher high. Obviously, you can but as said, it can be a bit lower hit rate.
Here is also a second mistake, another no-go criterion for me. Do you know it already? Go and look...
Yes, correct! ;) Firstly, we haven't seen new highs and secondly, the trendline touching points (1 to 2, 2 to 3, 3 to 4) are not at a similar length. The fourth touch comes too early/fast. Another rule which can ruin your "perfect" trade from the trendline.
So, two simple mistakes to avoid. To get a better success rate from the trendline you should wait for a new higher high formation and the market cycles should be quite similar between touching points.


Breakout trades.

If the trendline looks strong but cannot get any support from other criteria then I'll start to look at selling opportunities after the breakout.
As you can assume, this isn't as simple as some guys on YouTube will sharing with you. I have also some rules here to make breakout trades.

Firstly, the price should come from an all-time high or from a mid-term high, print a short-term lower high, and then breaks. This is a good scenario because then there are some FOMO retailers who bought from the top, got a little hope for a bounce upwards, and as you should know, really often they get punished who bought the top.
Secondly, and most importantly, the break must occur with a strong and powerful candle without any significant lower wick. Basically, if you have clean touches from the trendline then it has shown its strength and the strong candle break confirms it even more. How? If the price falls below the trendline just simply with small candles then it doesn't show the strength enough to trust it on the retest. A strong and powerful candle needed! We need to see that power because after the break we start to wait for a retest of it. The strong candle shows that the trendline is still valid but in vice-versa before it acted as support now it starts to act as a resistance. Another example.


Let's talk a little bit about the timeframes. Obviously, the higher is the timeframe the stronger TL is. If I analyze stocks then I trust the most monthly and weekly timeframe. Considering crypto, there I use Daily and 4H but most likely Daily. To be said, 1H is the minimum.


That's about it. The post got quite a big one. uuh...simple trendline yes?! ;) A lot of left unspoken (minor trendlines, how fast it can come to touch it and etc.) but in general you should get at least something from here to add to your analysis. Was fun to write it but this is just the beginning. I have 15 criteria to analyze the charts. Maybe I should write an e-book about technical analysis what you think!? :) Trendline is just one of them and it isn't even the strongest criterion on my list. Doing the analysis I have 15 criteria and depending on the timeframe 3 to 7 of these 15 must be in one strong area together! So don't just go for a trade/investment if you only have one criterion, the trendline.


Hopefully, you like it, all the best!
Vaido