When trading breakouts using trendlines, you need to first of all identify the nature of the market you intend to trade. Either a trending market or a ranging market, choppy or calm. This can be done by drawing the trendlines, channels or triangles.
How do you trade a breakout using trend lines?
You have to identify the current market trend first. If it is an uptrend, draw your trend line on the lower side of the trend/support trend line. For a downtrend draw a resistance trend line.
Your trend line should touch perfectly the higher lows for an uptrend and the lower highs for a downtrend.
When price breaks the trend line, it signals a probable reversal in the current trend, wait for the breaking candlestick to close below or above the trend line before you can place your order.
In case a confirmation of the break is above the resistance trend line, get ready to place a buy. If the breakout is on the lower trend line, get yourself ready for a sell after the confirmation of the breaking candlestick below the trend line.
Trend lines work better in a trending markets and you just require three points to validate your trend line.
Now let us have a look at some examples on how to trade breakouts using trendlines.
Below is AUDNZD, 4-Hour chart with a support trendline
From our chart above, the bearish candle close below the support trendline is confirmation for sell signal. The Stop loss is set just on the previous highs. The target can be immediate support zone or previous lows.
However, if you are a conservative trader, you can always wait for price to retest/pull back to the trend line before you enter the trade. This is usually now a bounce off the broken trend line preferably confirmed by a candlestick reversal pattern.
Let’s take a look at an example below on AUDNZD, Daily chart.
In the chart above, price broke out of the resistance trendline and then retested it as support.
The doji candlestick pattern bounce off the broken trendline is confirmation for buy entry. The stop loss is just set on the previous lows. The first target can be set on immediate resistance zone and second profit target on previous highs zone.
Trend lines are used on any kind of chart patterns to identify significant break out levels.
Some of the patterns include double bottom and tops, head and shoulder,triple tops and bottoms, and any pattern of your choice. The entry level is defined at the break of the trend line.
While trading a trend line break out, your target profit can be set depending on the price volatility and the past price behavior in the market such as levels of support and resistance. Stop loss should be set a few pips below or above the trend line for a buy or sell trade. This also depends on your risk to reward ratio.
Of course while trading other chart patterns, we use their specified target levels . To learn more on trading chart patterns you can take a small recap on chart patterns session.
For example let’s take a look at how you can trade the inverted heads and shoulders chart pattern below.
Entry level on the inverse heads and shoulders is at the break out of the neckline confirmed by the bullish candlestick closing above the neckline after the breakout. If we can take a look at the chart above,the breakout is identified by the black circle and at the same time it shows us the entry point level which is the completion of the second shoulder.
Like we said before under chart patterns session, your profit target point from entry point should be equal to the distance from the neckline to the head of the pattern as indicated on the chart above. Your stop loss set below the right shoulders or below the head depending on the volatility. Most important is to have a favorable risk to reward ratio.
How long you should hold an open position, is a personal thing for all traders. The decision is all yours. You know what your goals are as a trader, the kind of strategy you use to trade. All this starts from what you are? and What you want? If I am to answer, this...
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