How to form trading rules based on trend lines

How to form trading rules based on trend lines

Since the bulls are in control of an uptrending counter and set the agenda for the next bottom, an uptrend line acts as a support that keeps climbing over time. The best trading strategy in such a situation would be to buy close to the uptrend line. However, price may crash once this support is breached; so, traders also have to place a stop loss also on the uptrend line. 

Similarly, bears are in control of a falling counter and therefore, a downtrend line acts as a falling resistance. So the investors can sell / go short close to it, with a stop loss in place at the downtrend line. 

As mentioned in earlier editions of the Classroom, traders need to keep a close watch on to the volume generated when the price approaches the trend line. An increased volume usually serves as a confirmation to the trend line when it holds. 

The next rule is based on trend line breaking. 

Breaking of trend lines signifies that the investors’ expectation about that stock has changed. So, breaking of a downtrend line is treated as buy signal and that of on uptrend line is considered a sell signal. In both the cases, the trend line should be used as a stop loss. Here again, the volume is important and the impending price action will be more when a trend line is broken with increased volume. 

Rule based on angle of trend line 

The angle of the trend line is another important factor. 

An abrupt or sharply inclined trend line means that the current sentiment is extreme and may not be able to hold for a long time. For example, the sharp uptrend line, marked in red in the Reliance Industries Chart, was broken in short time. On the other hand, a relatively flat trend line means that the participants’ behaviour is moderate and therefore, the chance of a trend line holding for a longer period is high (see the green line on the chart).