If the trend line is heading down, then the market should decline as well; when the trend line advances, the market also should advance. Consider the trend line (green) plotted on the daily EUR/USD chart in “Crisscross” (below). The trend line follows the market, not the other way around. The market turns well before the trend line does, and can diverge significantly from the trend line. This is very similar to a moving average crossover.
We also notice that when the market diverges too far from the trend line, it will reconverge. Once the currency crosses the trend line, it is a confirmation of the directional change. Just like standard analysis, support turns into resistance and resistance into support. At the end of this chart, the euro is far from the trend line, so the risk is on the downside. If used independently, the trend line works best for identifying overbought and oversold conditions.
The formula for the trend (kijun) line is as follows:
Trend = (highest high + lowest low) / 2 for the past 26 days
The signal line works in conjunction with the trend line. A crossover above the trend line gives a buy signal and a crossover below the trend line provides a sell signal. The signal line is the dark red line in “Crisscross.”
The formula for the signal (tenkan) line is calculated as follows:
Signal line = (highest high + lowest low) / 2 for the past nine days
Without exception, the signals to sell and to buy will be late relative to the start of the downward and upward moves. This is because they are lagging indicators. They work to confirm, not forecast.