The trend is your friend except at the end where it bends.
--- Ed Seykota
Technical analysis is built on the assumption that prices trend. Trend Lines are an important tool in technical analysis for both trend identification and confirmation. A trend line is a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance. Many of the principles applicable to support and resistance levels can be applied to trend lines as well.
One standard definition of an uptrend is a succession if higher highs and higher lows. The trend can be considered intact until a previous reaction low point is broken. A violation of this condition serves as a warning signal that the trend may be over. It should be emphasized, however, that the disruption of the pattern of higher highs and higher lows (or lower highs and lower lows) should be viewed as a clue, not a conclusive indicator, of a possible long-term trend reversal. Uptrends and downtrends are often defined in terms of trend lines. An uptrend line is a line that connects a series of higher lows, while a downtrend line is a line that connects a series of lower highs.
It is not uncommon for reactions against a major trend to begin near a line parallel to the trend line. Sets of parallel lines that enclose a trend are called trend channels.
The following rules are usually applied to trend lines and channels:
Declines approaching an uptrend line and rallies approaching a downtrend line are often good opportunities to initiate positions in the direction of the major trend.
The penetration of an uptrend line (particularly on a closing basis) is a sell signal; the penetration of a downtrend line is a buy signal. Normally, a minimum percentage price move or a minimum number of closes beyond the trend line is required to confirm a penetration.
The lower end of a downtrend channel and the upper end of an uptrend channel represent potential profit-taking zones for short-term traders.
Trend lines and channels are useful, but their importance is often overstated. It is easy to overestimate the reliability of trend lines when they are drawn with the benefit of hindsight. A consideration that is frequently overlooked is that trend lines often need to be redrawn as a bull or bear market is extended. Thus, although the penetration of a trend line will sometimes offer an early warning signal of a trend reversal, it is also common that such a development will merely require a redrawing of the trend line.
The key to trading does not lie in following a specific line, but in recognizing that the trend represents the underlying momentum of the market, which is the direction your trades should take as well.
