One of the longstanding technical principles that applies to trading is that the markets move in trends. This was stated under the Dow Theory, at the start of the 20th century, and it still holds true and is used today. Of course, trends do not last indefinitely, and about half the time the market is not trending up or down, but moving sideways, sometimes called range trading or trendless activity, but prices move in trends enough that many people confine their trading to trend following methods.
When you introduce the power and convenience of contracts for difference to your trading, you make it possible to achieve far greater gains more quickly than with traditional markets, and following the trend is one of the less risky strategies used, which is an advantage to avoid the downside of an unsafe trade. While everyone thinks that they can spot a trend by eye, drawing a trendline on a chart gives you a measurable gauge of how the security will perform.
A trendline can be started with only two points, but needs a third for confirmation. A trendline in an uptrend is drawn between the two lowest points, and projected into the future. The third point touching and using the trendline as a support is important, and the more touches and rebounds that subsequently happen, the more solid the trend is proved to be. As noted by Dow, a trend will continue until something happens to change it, so a trendline will tell you all about the future support or resistance locations.
In a downtrend, you can draw a trendline going downward between two peaks, and again look for a third point to confirm the angle. In either case, you would expect the price to repeatedly retrace from the line while the trend was ongoing, and you can use this information to know where the price will reverse and trade accordingly. You are seeking to trade with the trend, and enter the trade as soon as possible.
The first basic strategy is to buy in an uptrend, and for this you will wait until the price comes down to the trendline during a retracement. As you can easily take a short position using a CFD, you can use the same technique when you see a downtrend, allowing the price of the underlying to come up to touch the line during a correction and then trading a short CFD.
According to Murphy, trendlines should encompass all the market action and be drawn to include all the days activities, whether transitory or not, although some analysts insist that the closing prices are more important and construct their trendlines to only use these. It is a matter of personal choice exactly how you draw the lines, and sometimes it will make no difference.
You must also watch for any violation of the line, as this can be the first warning that you get of the trend changing. Sometimes trends will change their angle, but if the trend continues, you can update the trendline to take account of this.
