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Lesson 29: Classic and Math-Based Trend Lines
Classic Trend Lines
What Are Classic Trend Lines?
Imagine you have a chart full of price movements. Classic Trend Lines are like drawing lines on this chart to connect important price points. These points could be the lowest lows or the highest highs.
These lines help you see the general direction of the market: is it going up, down, or sideways?
How to Draw Classic Trend Lines
It's a bit like drawing in a sketchbook. You take a pencil (or your mouse) and draw a straight line connecting at least two major points on your chart. These points are usually where the price changed direction.
The tricky part is deciding which points to connect. This can be different for each trader, making Classic Trend Lines somewhat subjective.
The Need for Continuous Adjustment
The Forex market is always moving, so a line you drew yesterday might not be relevant today. You need to keep updating your lines as new price data comes in.
A Bit About Edwards and Magee
These guys wrote a book in 1948 where they laid down some rules for drawing these trend lines. They suggested that ideally, the lines shouldn't be broken by price movements. But, some traders believe that it's okay if there's an occasional spike that breaks through.
Math-Based Trend Lines - The Linear Regression
What's Linear Regression?
Unlike the Classic Trend Lines, Linear Regression doesn't depend on your drawing skills. This is a line calculated and drawn by your trading software.
It's a mathematical way of finding the best-fit line through your data points. Imagine it as a line that tries to stay as close as possible to all the price points on your chart.
Advantages
It's objective and based on calculations, so there's no guesswork involved.
Your software handles all the drawing and updating, making it less labor-intensive than the Classic Trend Lines.
How to Use Linear Regression Lines
These lines start at a significant low point and end at a high point on your chart. You can even stretch this line further to predict where the trend might head.
When Classic Meets Math
Sometimes, your hand-drawn trend line might end up matching the linear regression line. This can be a great confirmation that you've accurately identified the market trend.
Practical Application of Linear Regression in Forex
Understanding Central Tendency
In Forex, there's this idea that prices tend to return to a central point, which can be represented by the linear regression line. If you extend this line from a recent high, you’re basically guessing the future 'center' of price movements.
Judging the Effectiveness of Trend Lines
When it comes to Classic Trend Lines, the more times the price touches the line without breaking it, the more reliable it is. But, if these touches are too far apart, you might need to redraw your line.
A Note on Chart Scales
Most Forex charts use what's called an arithmetic scale, where each step on the chart is the same size. But there's also a semi-log scale, where steps show percentage changes. The semi-log is great for long-term views or big price moves, but most Forex traders stick to the arithmetic scale for short-term trading.
Today, we've covered quite a bit about Classic and Math-Based Trend Lines. Remember, these are tools to help you understand market trends. They're not always perfect, but they can be incredibly useful. Practice drawing and interpreting these lines, and you'll soon get a feel for how they can aid your trading decisions.
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