An uptrend can be defined as a series of higher highs and higher lows. There is a certain degree of predictability to identifying key turning points that the price action will follow. The same can be said of a down trend.

When the price action is trending lower, a trader would expect to see a series of lower lows and lower highs. Once again investors would probably be able to identify when a corrective rally is likely to lose its momentum and begin to move back in the direction of the dominant trend.

The flow of market action during the trend cycle can be defined visually through the use of basic yet effective chart study tools. The trend line.

How to draw a trend line

A trend line can be simply drawn by connecting two swing points during an uptrend and then extending this line into the future. The same process can be followed in the event of a downtrend where the investor would connect two consecutive high swings.

In both cases if the price action is trending in one direction, then the investor should see a rising trend line that connects rising lows during an uptrend and a falling trend line that connects lower highs.

As if by financial alchemy the investor can now, with some predictability, work out through visual means where the price action is likely to naturally pullback to. This type of price movement is especially useful to swing traders whose aim is to participate in moves by buying into weaknesses during an uptrend and selling into strength during a downtrend.

What to look out for:

Trend lines do not always give investors the exact point of entry on the third pullback. This is because other traders are all too aware that swing traders will look to add positions at these levels and try to hunt for their stops. Therefore investors may see some volatility around the third intersection of price and trend line support and resistance with a series of fake outs and false moves that could keep investors guessing.

A trend line break could also give investors an early clue that a trend is about to change. A break beneath an uptrend line can be viewed as bearish if the price action on the first pull back fails to break above or sustain a move above the uptrend line.

Alternatively, a break above a down trend line can be viewed as bullish if the price action on the first pull back fails to break beneath or sustains a move below the downtrend line.

Understanding how a financial instrument reacts to a move to, or through a trend line is a difficult task as it requires a comprehensive understanding of short-term price patterns, price exhaustion or continuation analysis. Investors must also be able to master the correct placement of stops around these levels so as to ensure that the market volatility does not prematurely take them out of a profitable trade.