Trend Lines and Channels

Trend lines and channels are created by joining highs and lows together to create points of support and resistance. As long as price remains to one side of a line, they will trade in that direction.

Let’s first demonstrate how to draw in mechanical trend lines (Tom DeMark trend lines).

The whole point of demonstrating the following is to give the trader a mechanical approach to drawing in trend lines as a way to determine the trend, and to also determine the strength of the trend.

Bullish Trend Lines

- In a bullish trend, price will stay above a ‘support’ trend line.
- Therefore, bullish trend lines are only concerned with lows.
- The trend line will always slope up when looking from left to right.

Bearish Trend Lines

- In a bearish trend, price will stay below a ‘resistance’ trend line.
- Therefore, bearish trend lines are only concerned with highs.
- The trend line will always slope down when looking from left to right.

When drawing in a trend line, you want to join the most recent high/low to the high/low before it, and you want the high/low to be of the same make; in other words, you join a pivot high to a pivot high or a 2 bar trend high to a 2 bar trend high, or a 4 bar isolation high to another 4 bar isolation high, and then extend the line out to the right of the chart.

When joining highs together, the trend line must slope down when looking from left to right – as this is telling you it’s a down trend.

When joining lows together, the trend line must slope up when looking from left to right – as this is telling you it’s an up trend.

Here is a resistance trend line drawn in by joining the two most recent pivot highs together (E and H) to demonstrate that the short term trend is now down.

The way to use this method of determining the trend is to use a higher time frame. If the above chart was a weekly chart, the trader might look for short trades on the daily chart.

The strength of the trend is determined by the variable used if either of the trend or isolation high/low is used. For example, by joining 5 bar isolations together, you are in effect in a stronger trend than when using 2 bar isolations.

So far we have suggested some simple but effective mechanical methods for determining the trend. The discretionary trader can still use the methods suggested above but they may want to remove any mechanical rules and rather use their eye.

For example, the more experienced traders become, the less they require indicators and are able to rely more on a visual of the chart. Depending on the average time frame one wishes to trade, i.e. 1-3 months, 1-5 years, 1-5 days; a look at a chart with 3 to 5 times that data may be sufficient for some.

For example, Jill is an options trader who looks for medium term trends in price. She only wants trades that last between 4 to 10 weeks. For Jill then, a chart showing the last 6 to 12 months of price data will be her main chart for determining the trend. She may look at longer term too, but what she wants to see is a year long chart showing her that the trend is one way or the other.

Here is an example where the trend is clearly up:

If the trader wants to use trends lines or channels, from a discretionary standpoint, a trend line simply needs at least two points of reference. A channel needs at least three points, either two lows and a high or two highs and a low.

Here is an example of a down trending market where the trader has joined the highs and lows to create a parallel channel. If the trader only wants to trade in the direction of the trend they will only look to go short at times where price is closer to the upper line.

The slope of a trend line is also a reference tool for some traders. The steeper the slope the higher the chance for explosive moves, but it also carries higher risk of the trend coming to an abrupt end.

Here is a chart where the slope of the trend has been up the whole time but during the second half has become much steeper offering more explosive moves in less time.

Move on to Step 4 - Module 2 > Trading System Builder Tool Kit: Trading Rules > Trigger