Trend lines are diagonal supports and resistances drawn on upper and down side of the trend. It is the most commonly used tool by traders. It is simply a tilted support and resistance line.
Trend lines can be drawn by picking up atleast three previous lower highs for an uptrend and higher lows for a down trend. It is used to identify the direction of the entire trend.
Trend lines are mainly used to determine the direction of the trend.
How to draw a trend line?
- First identify the direction of a trend.
- The trading platform provides a trendline or line tool usually represented as a slanting small line(/) on the top left side above the chart. Select the tool.
- For an uptrend, connect the line from the low of one wave to the next higher low and then extend it out to the right to provide a projection of where the next lows could possibly occur.
- For a downtrend, connect the high of one price wave to the lower high of the next price wave and then extend it out to the right. The lines provides a projection for where future wave highs may occur.
- Choose atleast 2 -3 points of the higher lows below the price for an uptrend and then join them with a line.
- Do the same for the downer trend but this time choose the price tops of the lower highs above the price and join the points with the line.
The chart below shows trend lines drawn on AUDCHF, Daily chart.
Trend lines work as supports and resistance on the forex market chart. The more times price retests on a trend line the stronger it becomes.
How to trade using trend lines?
To trade trend line breakouts its advisable to always wait for a candlestick to close below the trend line or above. Since trend lines are diagonal supports and resistance therefore they behave the same way.
Trend lines can be traded like support and resistance levels. There are two different ways to trade using trend line;
Trading a bounce
Like we said trend lines can be used to identify the direction of the entire trend. As price continues to test the trend line, the stronger it gets. Therefore if price is in the uptrend and keeps on making higher lows on the trend line it signifies a strong uptrend and in so doing gives a buy signal.
On the other hand, if price is trending down and keeps making lower highs, it shows a significant strong downtrend therefore sell signals.
If you are to trade bounces using a trend line,
First identify the trend direction using a larger time frame
If it is an uptrend,draw an upward trend line connecting 2-3 higher lows (or higher swing lows)
Identify price retracements, that is wait for price to touch the trend line again.
As price bounces back off the trend line, place a buy trade at the close of the candlestick that touches the trend line and closes above the trendline in the direction of the trend.
Place your pofit targets on previous significant lower swing highs that you see on the chart.
You should do the same when trading in a downtrend but this time we use the lower highs to draw a trend line and we do take sell positions.
The GBP/USD, daily chart below shows how to trade bounces on a trend line in an uptrend.
Trading a breakout
A trend line break out can be traded in two ways:
The aggressive way of trading:
Here you enter a trade as soon as the breaking candlestick gives a confirmation below the trend line for an uptrend or above the trend line for a downtrend.
The chart below shows abreak out on a trendline on AUD/CHF, H1 chart.
Conservative break out trading
A breakout can be traded by first waiting for a retest of the price movement back to the broken trend line and enter on the second confirmation of the break or bounce. This is known as the conservative way of trading.
The chart below is AUD/CHF,Daily showing how to trade a break out after a retest.
Place your stop loss slightly above or below the trend line depending on your entry point.
If prices retest the breakout level and continues that is likely to be a fake out break.
A false breakout is when price breaks through the trend line and then goes back to retest and the candle closes above the trend line. The false break on a lower trend line means that some of the buyers in the market haven’t given up yet and so the trend is still strong . A false break on the upper trend line, shows that there were still some of the sellers in the market and so the downtrend is likely to continue.
The chart below shows a false break out on a lower trend line in an uptrend. GBP/USD, Daily chart.
From the above chart, price gave a confirmation for a break out but shortly bounced back and continued in its initial trend direction. This simply means the buying pressure was still strong compared to the selling pressure.
Such scenarios are very hard to avoid as long as you are trading in the forex market, that’s why we always emphasize trading with a stop loss to limit your losses.
As you successfully choose to trade using trend lines, you must not forget that;
- Trend lines can be used as support and resistances there for can be used to identify signals to trade.
- An uptrend line is drawn below the price movement on an up trend and a down trend line is drawn above the price on a down trend.
- Trend lines are drawn at an angle and used to determine a trend and to identify signals to trade
- Trend lines can be drawn on an up-trend, areas of congestion and a down-trend.
- To draw a trend line, you must have at least two points, on a down trend two highs must be connected by a line and up-trend two lows must be connected and at least three points to make it valid.
- The more times the price touches the trend line the stronger it becomes.
- Never try to force a trend line to fit, if it does not fit on the chart. it’s invalid.
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...