This week, we’re going to tackle how to cash in drawing and trading trend lines. Yes, I know a lot of you out there are literally geniuses at applying support and resistance lines. Left to you alone, you could make a fortune on just support and resistance lines. But mention drawing trend lines, and I’m sure I’ll get thick frowns from you guys that will make Godzilla look like a boy scout.
As a matter of fact, drawing trade lines is the most common and most popular among most forex traders. Not only are you identifying the trend, you’re also determining the strength of the trend. You’re putting all the dots together as to whether a setup can be traded or not.
So we’re going to do a few things. We’re going to define what trendlines are including looking at two types of trend lines. Next we’ll get to the most exciting part – How to draw trendlines, including ground rules on drawing trend lines. Finally we’ll touch on trading trend lines.
But first things first!
What Really Are Forex Trend Lines?
Well, forex trend lines are levels that help you identify and detect the direction of market trends. Imagine looking into the crystal ball and predicting what your future will be like. Well,that’s what traders do with trend lines. Some of you might be thinking “yeah right” but trend lines do offer value information as far as potential trades go. Not only do trend lines depict the current direction of a price move, but they also help identify support and resistance levels for the price. Trend lines also help you make up your mind on crucial factors such as entry and exit stops, profit taking and placing protective stops to avoid the harrowing possibility of your account going up in smoke.
How Do I Draw a Trendline?
Fairly straight forward. If you’re have a chart with an uptrend in front of you(i.e. the bulls charging upwards), start your trend line from the bottom of the line. Then draw the line a little further until it connects with two or three swing low/high points without interfering with other parts of the price action.
But it’s the complete opposite with the bears downtrend. You start the trendline at the highest possible price point(Imagine looking down from the summit of Mount Everest). Then continuing stretching the length of the trendline until it touches two swing high/lows without interfering with the price action.
Now there are two types of trendlines you will be using when measuring trends. Most of you may have across these trends while reading my posts. But it doesnt hurt to refresh your memory.
As if it’s not obvious to you now, bullish trendlines are utilized to measure bullish trends that are on the up and up. In case some have forgotten, bullish trends have the bulls running the show.In other words,the value of the currency pair is rising, with higher highs and higher lows being the end result.
Now Where Do I Place The Bullish Trendline?
Just place the bullish trend line below the price action. Next connect the higher lows of the trend line, creating a level of support for the bullish trending. Now let’s see what the bullish trendline looks like.
As you can see, the green line represents the bullish trendline. The two arrows point to the higher lows or swing lows, as they’re popularly known. Just connect the two swing low points and you’ve got yourself a bullish trend line. The more lower lows contained in the trend line,the stronger the trend line.
Next up is:
You don’t need me to tell you that bearish trends are the complete opposite of their bullish brethren. As the name suggests, the bearish trend suggests a drop in price with lower highs and lower lows being the end result of the bears downhill slalom. In this case, you use a bearish trendline to ascertain price action while the price took a nose dive.
Where Do I Place The Bearish Trendline?
Insert the bearish trendline at the highest point of price action(Imagine what it feels like looking down while standing on top of Mount Everest). And then connect the lower highs and lower lows. Let’s see what the bearish trendline looks like.
The sloping red line is the bearish trendline. And the two candlesticks indicated by the red arrows represented the highest points on the price action. Just connect these two points and you have yourself a bearish trendline.
Now before we wrap up:
A Few Things To Keep In Mind
- To get a valid trend line, make sure you see at least two highs or lows. Just to confirm, you may need at least three tops or bottoms.
- Make sure your trend line is not to too steep. Or else you may end up with a distorted view of the price action-which of course could blow your profit prospects to smithereens.
- Just like support and resistance levels, trendlines also have a strong backbone. With every hit that they take, they become more stronger.
And lastly, PLEASE PLEASE And I repeat- PLEASE! PLEASE! Whatever you do, do not force your trendlines to fit the market. If your trendline does not reflect the prevailing price action, it’s not a valid one. Dont push and force anything that isn’t there, unless you don’t really care about the sanity of your forex account.
Here are some even more critical facts you need to keep in mind.
Think of The Trend As an Area Not a Line
When drawing a trendline, you need to think of the trend not as an isolated line but a whole area. Just because the price action breaks the trendline doesn’t necessarily mean that the trend has been broken. Some of us have this weird impression that just because the lower ends of the candlesticks strays off the trendline it means the trendline has broken. NEWSFLASH! ABSOLUTE NO! You need to keep in mind trendlines take a while to mature, and when they do mature, you’ll catch a lot of price reactions along the trendlines. And often time,these price reactions transform into the dreaded false breakout traps that rookie traders always seem to fall into.
Let’s take a look at a trendline in action on the USD/CAD currency pair.
Right in front of us is long bearish trendline. courtesy of the bears. The third lower high(third arrow pointing at the full-bodied candlestick) confirms the trend. Like I said I said earlier,you’ll need a third top to confirm the trend. Then notice the yellow circle encircle the lower low. That candlestick has gone off the trendline.Again, as I mentioned earlier, just because a candlestick’s wick strays off the trendline does mean the trendline has been broken. It’s all part of the trendline’ maturation process.
However, numerous candlesticks hovering around the area suggests a major rejection exercise being carried out against the price as it tries to break through the trendline. consequently, price drops before it finally breaks through the trendline at the final attempt.
Now comes the fun part-trading trendlines.We’re going to look at three trading scenarios that unfold along the trend line. The first one is:
Trading The Trending Move
First make sure you have your three confirmations. Once you get your third confirmation, you now have the green light to trade on that trendline. Let’s look at a”Trading the Trending Move” illustration on the AUD/USD graph
Here the blue trendline represents the bearish price drop(Or the bearish slalom as I like to call it.) The green arrow pointing at the full bearish candlestick represents the third confirmation signal that we alluded to earlier. Once you get that confirmation, you can enter your sell trade(or go short as we also say).
Also notice that another lower low forms, causing another correction to the trend. This causes the price to take a further plunge, thus,creating another lower low. Now take a very close look at the bullish candle circled in red at the end of the trendline. That’s a clear sign that the bears momentum is evaporating, and that it’s time close the trades. So when you see such a situation unfolding in future trades you know what to do.
Next up is:
Trading Trendline Breaks and Reversals
Now that we’ve gotten past trading swings using trend and counter trends, let’s look at trading trendline breaks and reversals. In as much as we love the bulls shooting for the hills,we also know that situation is not always permanent. That as some point, there is going to be a reversal, sometimes of astronomical proportions. And when that happens, the grizzly bears take over and push price downwards, forcing it to roll down the hill -sometimes at dizzying speeds.
In as much as we’d like trend reversal confirmations to be straightforward, it’s not always the case. The veterans of this sometimes crazy business will tell you that it’s not an exact science. It tallies with my assertion earlier that just because a candlestick accidentally strays off a trendline doesn’t mean the trendline has been broken. So to make life easier for you rookies out there I’m going to show you four scenarios you should recognize when using trendlines to confirm a trend. We’ll use the ever famous GBP/USD pair to illustrate.
What you see above is the four scenarios which help confirm a trend reversal. Now, since I’m a very nice guy, I’m going to break down and explain all four of the above scenarios to make life just that much easier for all of you.
We’ll start with:
- Price Breaking Trendline
Phase one shows the price breaking the bullish trendline acting as a resistance level.. The strong red candlestick in the red circle represents the actual breakout by the bears. It’s the beginning of their traditional slalom run.
2. Price Decrease Below Previous Bottom
The bears continue to hold sway as price continues to decrease further. The strong red candlestick in the red circle is indicative of the bears pushing the price below the previous bottom and the initial swing low that was created as a result of this price drop. The horizontal line at the circled swing low serves as the alarm bell or triggern for the eventual trend reversal.
3.Broken Trendline Under Attack
The Bears are really milking their newfound momentum like nobody’s business. They re really attacking the trendline by constantly retesting the broken resistance trendline to try to put it out its misery and roll downhill. You can place your trade entry after the close of the strong red candle. However, there is one little secret about these trend reversals you need to know. The retest doesn’t have to touch the trendline.Why?because the trendline is considered an area, not a level. Even further, the price may do even do a 360 on you by shooting upwards beyond the decimated trendline.
4. Support Level Also Takes a Hit
So, not only does the resistance level take a hit from the bears, but the support level suffers the same indignity from the bears also. The black line in this scenario happens to be the poor support absorbing all this punishment. But take a close look at the strong candle stick closing strongly below the support line. This would be the perfect place to put in a sell order(or go short as we say).
If you’re still pulling your hair over drawing and trading trendlines, I suggest you seek the advice of Identify Support and Resistance Levels With Price Action Analysis
Well, that’s a wrap for “How to Cash in Drawing and Trading Trend Lines.” As you can tell, trendlines are crucial too; for forex traders as far as predicting the future price action goes. Just make sure your trendline fits directly on the chart and you will reap the benefits nicely.
Til next time take care.
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