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Before you start trading, you need to identify the trend of the market.
This involves finding the general direction of price movement. We can observe on any chart and in any time frame that markets do not move in a continuous straight line but instead create a series of peaks and troughs. By studying the direction of these tops and bottoms, we can see whether the trend is up, down or in a range.
When price action creates higher successive peaks and higher successive bottoms, then we can say the trend is up.
On the other hand, when lower and lower peaks are formed, along with successive lower troughs, we can say the trend is down.
When price action moves sideways to create horizontal peaks and troughs, the trend is said to be in a range.
Trend Lines
To help us identify the trend of the market, we use trend lines.
Downtrend Line
In a downtrend we draw a straight line downward, connecting as many successive peaks as possible.
This is how a downtrend would look like on an MT4 chart.
Uptrend Line
In an uptrend we draw a straight line upward to connect all the successive troughs.
This is how an uptrend would look like on an MT4 chart.
The more peaks or troughs are connected with the trend line, then the more valid the trend line will be. If the trend line connects more than two points, it is called a valid trend line. If only two points are connected, then it is a tentative trend line.
A break of the trend line could suggest a change in the trend. This will be discussed in more detail later.
Remember that while a penetration of a valid trend line is a signal that the trend might reverse, it could sometimes be a false signal. We could wait for at least two closes of the candle above or below the trend line to confirm.
Channels
The channel is a variation of the trend line technique. Prices trend between two parallel lines – the trend line and the channel line. The longer the channel remains intact and the more often it is successfully tested, the more important and reliable it becomes.
Linear Regression Channel
Apart from a simple straight line, the linear regression channel can be used as a type of trend recognition technique. It consists of two outer parallel lines on either side of the linear regression line to form a channel within which prices will move.
The linear regression line in the middle is basically a line that best fits all the prices (that we are considering). The upper and lower lines are usually two standard deviations above and below the linear regression line.
On the MT4 chart the channel is drawn from left to right. In an uptrend it will be drawn from the lowest trough upwards to the highest peak on the chart. In a downtrend, the channel is drawn from the highest peak downwards to the lowest trough.
The longer the channel line remains intact, meaning the longer the price action remains within the channel, then the stronger the trend will be.
Below is an example of a linear regression channel in a downtrend. We can see that for the most part, prices remained within the channel, keeping the downtrend intact. However, prices eventually moved out of the channel and began moving upwards. This gave a signal that the downtrend ended.
And here is an example of a linear regression channel in an uptrend.
