BECOMING AN EXPERT TRADER
(Part 7)
How to draw valid trend lines
The trend lines can connect any two points in a chart(technically). But, most chartists agree that using three points or more is what makes a trend line valid. In some cases, the first two points can be used to define a trend in potential, and the third point (extended in the future) can be used to test its validity
So, when the price touches the trend line three or more times without breaching it, the trend can be considered valid. Testing the trend line multiple times indicates that maybe the trend is not a mere coincidence caused by price fluctuations
Scale settings
In addition to choosing enough points to create a valid trend line, it’s important to consider proper settings when drawing them. Among the most important chart settings is the scale settings
In financial charts, the scale relates to the manner in which the change in price is displayed. The two most popular scales are arithmetic and semi-logarithmic (semi-log). On an arithmetic chart, change is expressed evenly as the price moves up or down the Y-axis
EX, a price change from $5 to $10 would cover the same distance on an arithmetic chart as one from $120 to $125. On a semi-log chart, however, the 100% gain ($5 to $10) would occupy a much larger portion of the chart, as opposed to the 4% increase of the $120 to $125 move
It’s important to consider the scale settings when drawing trend lines. Each type of chart may result in different highs and lows and, thus, slightly different trend lines
FINAL THOUGHTS
The choice of points used to draw trend lines will affect the degree to which they accurately represent market cycles and real trends, making them somewhat subjective
For instance, some chartists draw trend lines based on the body of the candlesticks, disregarding the wicks. Others prefer to draw lines according to the highs and lows of the wicks
So, it’s important to use trend lines in conjunction with other charting tools and indicators.
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