Price Action: How to Understand Trendlines

Trendlines typically connect the lows of a bull channel. The trend channel line is drawn at the highs of the bull channel. Together they contain the price action within a channel. Generally, these two lines are parallel, but they may also converge. The direction can be upward, downward, or sideways.

As the trend develops, price frequently breaks through the original trendline, forming new lows. At that point, you need to draw a new line connecting the new lows. As the market evolves, tight channels develop into broad channels, and broad channels may be broken through and then retested. Drawing trendlines and channels is not a one-time task but a process of continuous adjustment. You need to keep drawing lines as the market progresses, connecting swing lows to see if they can reasonably contain the price action while helping you interpret the market's story.

Another way to draw trendlines is to first draw the trend channel line — that is, connect the highs of the channel — then shift this line down in parallel to see if it matches the lows. This is how you find the trendline. If you find this channel line does not work well — for example, price does not react to it clearly — then consider that the current structure might be a wedge rather than a channel. In that case, you can directly connect the swing highs and see that it is a bull wedge.

Both drawing methods are correct. A wedge channel drawn using swing highs and lows will almost certainly contain all price action but will produce more breakouts. A channel drawn using a trendline plus a parallel line will look cleaner, and when a breakout does occur, it tends to be more meaningful because breaking a parallel channel is less common, while breaking a wedge is very common. Regardless of the method, our goal is to draw a channel that both contains most of the price action and reasonably reflects the price behavior.

It is important to remember that the trendline itself is not as important as the price action near the trend. Drawing lines is just to help us anticipate what might happen, but we should not make decisions simply because the line is there. Instead, we need to watch how price reacts near the trendline. For example, when price touches the trendline, whether a reasonable buy or sell signal appears — that is the key to deciding whether to enter.

Regarding trend development, Al mentions that trendlines become increasingly flat. Every bull channel is actually a bear flag that will eventually break below the trendline. After each break, a flatter new trendline forms, until the bear trendline gradually becomes clear and the market truly transitions into a bear trend. Most bull channel breakouts fail, especially the tighter the channel, the higher the probability that downward breakouts fail. Strong bulls continuously buy at channel breaks, but eventually when a truly strong breakout occurs, even strong bulls will buy for the first time. Whether it becomes a true major trend reversal depends on the strength and quality of the breakout.

Therefore, most trades should follow the trend. For example, in micro futures, a channel develops like this: initially you draw a channel, but find the market does not respect it, so you need to adjust. As the market progresses, you find a more similar slope between several lows, then draw a parallel line to form a more reasonable channel. If price produces a failed breakout and returns inside the channel, that is a credible overshoot of the channel and typically retests the trendline.

Drawing channels requires constant trial and adjustment. The goal is not to mechanically connect dots but to reflect the story the market is telling as accurately as possible.