Let us start this second part of the article with the first thumb rule that you need to follow everytime you start creating a trend line.
“Always confirm a downward or upward trend only when minimum three points are lying on the same trend line.”
When drawing, the first two points are considered as the beginning of the trend line, and the third point is considered as the confirmation of the slope. The following chart shows a bullish trend with the points that make a slope:
According to the chart, the trend starts with the circle no. 1 followed by no. 2 and the circle no. 3 confirmed the trend. The four arrows are showing the supports that are in the area of the trend line.
Second Thumb rule:
“It is not important that a trendline should touch the candlestick top or bottom wick or its body. The trend of a currency pair is not in a single line, but the whole area that the line covers. ”
When creating a trend line, it is possible that the wick of a candle may shoot up past the line. Let us consider a bullish trend; to create a line, you will analyze the body bottoms and the lower candle wicks. A wick coming out of the line does not affect the whole trend line as you are checking the whole area, not just the line.
You must keep in mind that with the maturity of a trendline, there is a possibility that the price action also matures which ultimately leads to false breakouts.
Here is the chart of USD/CAD currency pair showing trend confirmation and false breakouts:
The chart shows a bearish trend where the third point is confirming the trend is creating a nice trendline. According to the second thumb rule, the whole area covered by the trend line is considered instead of the points on the line. So mostly all the candle wicks are inside that area except for one at the top and a few at the bottom.
As the candle wicks shooting out are more than one at the bottom, there is a high probability that the price is trying to break through and this ultimately leads to a significant drop in the currency price before finally breaking the trend.
A tip for the beginners: Your broker may provide you the facility of automatically creating a trend line, but these are not reliable. It is better to create the trend lines on your own as a single wrong move can break the profit opportunity.
Now that you have got an idea about the thumb rules to create the trendlines, let us move on to the third part of our article.