Trends and trendlines: identifying the market's direction

"The trend is your friend" is probably the most repeated phrase in trading. Yet you still need to be able to look at a chart and say whether there is a trend, and which way. Good news: there is a simple, objective definition based only on price highs and lows.

Highs and lows: the definition of a trend

Price never moves in a straight line. It advances in waves: a push, a pullback, another push. Each push leaves a high (or swing high), each pullback a low. The way these points follow one another defines the trend.

• Uptrend: each high exceeds the previous one and each low stays above the previous one. These are higher highs and higher lows.
• Downtrend: each high is lower than the previous one, and so is each low. Lower highs and lower lows.
• Range (or trendless market): the highs cap out at the same level, and so do the lows.

This reading has a huge advantage: it also tells you when the trend is under threat. In an uptrend, as long as the last low holds, the structure is intact. If price breaks that low, the sequence of higher lows is broken. That is not necessarily a reversal, but it is the first warning sign.

Drawing a trendline

A trendline is a visual way of following that structure. In an uptrend you connect the lows; in a downtrend you connect the highs. The line then acts as dynamic support (or resistance) that rises or falls with price.

1. Identify two clear lows in an uptrend (or two highs in a downtrend), far enough apart.
2. Connect them by touching either the wicks or the bodies, but keep the same rule across the whole chart.
3. Extend the line to the right.
4. Wait for a third touch: that is what confirms the line in the eyes of other traders.

The angle matters too. A very steep line, steeper than roughly 60 degrees on your screen, reflects a runaway move that cannot last at that pace: it will break quickly, often without the underlying trend changing. A moderate line holds longer and gives more reliable entry points. Bear in mind that the angle also depends on your chart's scale: it is a visual cue, not a measurement.

The range: when there is no trend

Markets spend a good part of their time with no clear direction. Price then oscillates between a ceiling and a floor, making neither new highs nor new lows. That is a range. Trend tools work poorly here: buying every break of a high amounts to buying at the top of the band.

When a trendline breaks

A broken trendline does not mean the market is reversing. Often, price simply moves from a strong rally into a range, or into a slower rally. The real signal of a trend change remains the structure: in an uptrend, a break of the last low, then a high lower than the previous one.

There is a useful variant of the trendline: the channel. Once you have drawn your line of lows in an uptrend, draw a parallel line through the highs. Price then moves between the two, as if on rails. The lower line acts as a buying zone in the direction of the trend, the upper line as a profit-taking zone. When price can no longer reach the upper line, it is often a first sign of fatigue.

Also keep in mind that each timeframe has its own trend. An H1 chart can have been falling for two days while the D1 remains perfectly bullish: the H1 decline is only a pullback within the bigger trend. Before labelling a market, always specify which timeframe you are talking about. This point is developed in the lesson on multi-timeframe analysis.

Your turn

Take three D1 charts: EUR/USD, gold and the S&P 500. For each one, note the last four highs and lows and decide: uptrend, downtrend or range? Then draw a trendline if the structure allows it. This ten-minute exercise, repeated every week, will keep you out of most counter-trend trades.