Crypto trading is volatile, and traders are constantly looking for ways to profit from it. Using technical analysis is one of the best ways to identify trades in volatile markets.
Technical analysis describes past price action and extrapolates it forward. Of course, nothing lasts forever, which is why traders carefully place a stop-loss on each trade at certain price levels, based on the analysis.
Over the next few minutes, we’ll discuss a popular technical analysis tool called trend lines. Many traders love using trend lines because they provide excellent risk versus reward.
Why Is Technical Analysis Important?
It’s often said that Fundamental analysis is an approach used by cryptocurrency investors to establish the intrinsic value of a crypto asset.... will help you spot good crypto to trade, but technical analysis helps you spot the entry and exit points of that trade.
Crypto technical analysis involves following patterns from the asset’s price history to determine what might happen in the future. It’s based on the fractal nature of the market, and on the fact that the patterns recur over and over on a variety of chart time frames.
As these patterns frequently appear, the trader can identify good entry and exit price points for trading the cryptocurrency. Essentially, technical analysis tells the trader at what price level to invest in the crypto and the right time to withdraw from the trade.
As a result, technical analysis is crucial to the net profit or loss of your trading account.
What Are Trend Lines?
As the name suggests, trend lines are used in technical analysis to determine the direction of a trend. They’re drawn along the extreme points of the trend. If prices are consistently moving higher, then the trend line will be slanted upward. If the market is in a downtrend, then the trend line will be slanted downward.
More importantly, trend lines are used to determine support and resistance levels. Support is the place where sellers stop selling and buyers start buying. In support, the imbalance of buyers and sellers shifts toward the buyers. As a result, you typically see prices rebound higher off of support.
The opposite is true for resistance. Resistance is the ceiling on the chart that appears to hold prices down. Buyers see prices getting too high and they stop buying. Sellers begin to emerge because the asset is no longer moving higher. This forms a level of resistance that appears to repel prices lower.
Traders can easily identify support and resistance that recur at the same price level. This is known as horizontal support and resistance.
However, support and resistance levels don’t have to be horizontal. Support and resistance levels can also slant upward or downward with trends. It’s these upward and downward trends on which traders focus: they draw trend lines to help them identify entry and exit points for their trades.
In the Bitcoin chart above, prices are trending higher. Each time Bitcoin dips, it finds support near the support trend line, bouncing higher and creating a succession of increasingly higher lows.
It’s important to note that support trend lines don’t last forever. Eventually, they break. When the trend line is broken, prices sometimes revert to the underside of the broken support line before proceeding lower. On the Ethereum chart above, we can see how the support trend line eventually breaks. Later, prices rally back up below this broken support line, which now acts as new resistance.
As prices trend lower, resistance trend lines begin to form. This provides the crypto trader with a zone in which to consider selling short.
Another way crypto traders use trend lines is to buy breaks of resistance and sell breaks of support.
In the Bitcoin chart above, prices consolidate for several weeks in early March 2021. A trader can draw a resistance trend line, then wait for a break higher. In early April 2021, Bitcoin finally breaks higher above the trend line and continues to rally. The break above the trend line is a signal the correction may be over, and the market is ready to resume its uptrend.
How to Draw Trend Lines on Crypto Charts
Drawing trend lines is more of an art than a science. Therefore, it will take a little practice to train your eyes where to draw them for maximum benefit.
When trend lines are drawn correctly, you’ll see the market react at the line. Perhaps the market eventually breaks through the line, but first, you should see it dances around the line as if it’s going to reverse.
In the Bitcoin chart above, the line is drawn at points 1 and 2. When the line is extended further to the right, point 3 creates a reaction bounce higher. This bounce is eventually retraced and Bitcoin collapses through the trend line. Bitcoin eventually comes back to retest the bottom side of the trend line near point 4.
Sometimes, that third touch of the trend line produces a large trend, while at other times it’s merely a “fake-out.” You’ll find more success drawing your trend lines when you place them at common reaction points.
Let’s go over specific examples of how to draw ascending trend lines in an uptrend (uptrend line), and descending trend lines in a downtrend (downtrend line).
How does one draw trendlines? Well, drawing a trend line is fairly easy once you get the hang of where to start. As you look at an uptrend line, identify two or three common low points. These low points should be creating a succession of increasingly higher lows.
Once you’ve spotted these low points, activate the trend line drawing tool on your charting software. Then, click at the lowest point on the trend. Make a second click toward the right at another common low point. If your trend line doesn’t extend farther to the right after your second click, then you need to activate this setting to enable the extension of the line to the right.
After you’ve set the ascending trend line, make sure the line is crossing through the outer edges of the candle wicks, and not through the bodies.
On the Ripple chart above, there appear to be some common low points where a trend line can be drawn. After drawing the line at the three low points, make sure the line is extending farther to the right.
Fortunately for Ripple, the price does retreat to the trend line on multiple occasions. This tells us that the trend line’s implications for the market are important. Eventually, prices break below the trend line, eventually retesting the underside after the break.
Drawing a descending trend line is similar to drawing an ascending line, but in the downward direction. Descending trend lines are found in down trending markets.
First, look for a cryptocurrency market that’s experiencing a consolidation where prices have been correcting lower.
Second, look for two or three common high points within this correction that reflect a series of lower highs.
Third, activate the trend line drawing tool on your chart. Click first at the leftmost high point, then make a second click toward the right to finish the line. Your drawn line should cover the higher extremities of the candle wicks, and not pass through the bodies.
Make sure the trend line is extended to the right.
We know we’ve drawn the trend line correctly when it passes through the highs of the downtrend. As the price unfolds going forward, we see the market coming back into the descending trend line, creating future trading opportunities.
Again, trend lines don’t last forever. Eventually, the price breaks as Cardano (ADA) rallies above the resistance trend line.
An Example of Trend Line Trading Strategy
There are easy ways to identify trading opportunities by using trend lines. We’ll review two simple strategies for trading trend lines to help you identify good risk-to-reward trades.
First, find a market in a confirmed uptrend and draw a correct ascending trend line. Extend the line to the right and look to buy the next time the price retreats back to the trend line.
As the market reaches the trend line, wait for another piece of bullish confirmation, such as a bullish candlestick formation or another indicator turning positive.
On the cryptocurrency chart for LINK, above, the price corrects back to the ascending trend line, then carves a bullish engulfing candlestick formation on the 2-hour chart. Once the additional confirmation is in place, go long and place your stop-loss just below a recent swing low, which must be below the ascending trend line.
To figure out your take-profit level, calculate the distance between your entry and stop-loss, double that amount and then add it to your entry price.
The second trendline trading strategy involves descending trend lines. With a lot of investment going into crypto, the bull market rallies have tended to last longer than the bear market corrections. Therefore, when the cryptocurrency market is experiencing a bear market correction, it’s an opportunity to invest at cheaper prices.
For example, when Bitcoin collapsed in the summer of 2021, a trader could draw a descending trend line on top of the downtrend. Then, when prices break above the descending trend line, it’s a signal that the mood of the market is changing from bearish to bullish. A trader would enter long on the bullish break of the trend line, while placing their stop-loss just below the swing low.
After breaking the descending trend line, Bitcoin goes on to gain 60% in about six weeks.
Things to Consider When Drawing Trend Lines
Aside from drawing trend lines, other things could impact the trend in the long run. It’s wise to check into these items before committing to a trade.
Market trends tend to follow the trading volume. As market prices reach an ascending trend line and then bounce, look for volume to increase to indicate the support level for the new trend. If the volume is falling as the price is rising, this may be the signal for a false break higher, and possibly lower lows on prices.
The crypto market is fractal, which means the patterns you identify on longer-term time frames can also be found within shorter-term time frames. However, the signals generated on the shorter-term time frames tend to be less reliable, because there’s not as much data going into the creation of each price bar.
Therefore, give less weight to the signals found on the minute charts in favor of the larger trends.
The Bottom Line
Trend lines are one of the simplest and most basic tools available to identify trading opportunities. Trend lines are easy to learn and quickly implemented. For all traders, it is important to learn how to read crypto charts – with trend lines, you can get a good grasp on price movements.
A trader can use trend lines to identify opportunities in either a bull or bear market, and within any chart time frame. However, be mindful that signals generated on minute charts have a greater possibility of being false signals due to the smaller amount of data they contain.