Previously, we went into what support and resistance levels were, and how traders could leverage this to get an indication of when to enter and exit the market. In this article, we are adding trend lines and channels to your arsenal of trading tools.
Image Taken from BabyPips
A trend line helps traders to analyse whether the market is in an uptrend, downtrend, or sideways trend.
In an uptrend, the line is drawn to connect the support levels. Conversely, the trend line of a downtrend would connect the resistance levels.
When drawing a trend line, a trader would connect two major lows (uptrend) or two major lows (downtrend). For increased accuracy, it is always better if there are three points of contact to confirm the trend.
Drawing trend lines is a simple process, but can become misleading if a trader forces a trend line where none exists (e.g trying to force an uptrend line to fit into a sideways trend market). It is important to be objective when drawing trend lines; do not chart the outcome you want to see, but the reality of the situation.
Trend lines are a good way to get an overview of the market, and the time frames can be adjusted to suit your style of trading and investing; this does not mean that you should reduce the time frame to a minute and assume that the trend is accurate. Cryptocurrency markets can be volatile, and zooming in too closely is not always advisable. Use a trend line for daily or weekly, or even monthly, to get a clearer picture of what the situation is like.
Remember that the steeper the line is, the more likely that it will break. Trend lines with a more gradual gradient tend to be more stable and accurate, and if they are tested multiple times they tend to become stronger.
Now that we have covered trend lines, we can go a step further and look at channels.
To make a channel, draw a line that is parallel to the trend line and position it to line up with the most recent peak (uptrend) or the most recent low (downtrend).
What does the channel mean?
The channel has a couple of key purposes that are useful for traders.
1. It allows a trader to know what the state of the market is. Are we in a bull run? Or is the market currently led by the bears? A well-drawn channel can give a clear picture, and allow for a calculated response.
2. It indicates good entry and exit prices. Channels show the support and resistance levels for the current trend.
When to Enter/Exit?
In general, it is a good idea to enter the market when prices have hit the lower trend line, and a good time to take some profit when prices touch the upper trend line.
Before you get carried away riding the wave, bear in mind that channels have to be drawn in parallel. If it does not fit (the lines are not parallel), the channel is likely inaccurate. Just like the trend line, forcing a channel could lead to poor trades or investments.
Even when channels have been drawn accurately, it might not be the best idea to buy or sell immediately when the price as touched the support or resistance level. As mentioned in our previous article, these levels are not set in stone; they can, and often will, break.
For those who sell at the resistance level and it breaks, it means a loss of potential profits. On the other hand, those who buy in at the support level could end up losing their funds as the support level breaks, and price dives down further.
It is always better to wait for the ‘bounce’: a confirmation that the level has not yet been broken. While this means that you do not get the lowest entry price, or the highest exit price, it is a safer option to prevent unwanted loss.
Stop losses are set in place to ensure that you are not overly committed to a trade: when the level breaks and things are not going your way, a stop loss helps you to mitigate losses, saving your funds for the next trade.
It is impossible to be right 100% of the time: as long as you win the right trades, and minimize the damage from losing trades, you will always remain profitable.
These are some of the basic tools used by traders to estimate entry and exit prices. While not foolproof, they do give a good sense of the market, give an idea of when is a good time to buy and sell, and more importantly, prevent unnecessary losses by having a ‘safety net’ in place.
Stay tuned for the next article, where we introduce more advanced tools to improve the accuracy of your trading.
21 April 2018