How to trade using Trendlines?

To trade using Trendlines in Forex, you must know how to draw proper Trendlines. In this lesson, we’ll discuss what trend lines are, how to draw them and how to trade using trendlines in forex profitably.

Trend lines are diagonal supports and resistances.   You can use trendlines both in an uptrend and downtrend.

 Most traders use trendlines because with trendlines, you can easily identify the market trend.  When you draw a trendline, price moves as it leaves marks on the trendline.

  A trendline is simply a tilted support and resistance line.

How to draw trendlines in forex?

To draw a trendline, you need to look at price lows and highs.

Since a trendline is just a tilted support and resistance, it behave the same way as support and resistance.

In addition to that, trend lines are mainly used to determine the direction of the trend. The downtrend and the uptrend.

As the name suggests, trend – line.  A line that shows a trend; simple!

Below are steps to draw proper trendlines

  1. First identify the direction of a trend.
  2. 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.
  3. For an uptrend, connect the line from the low of one wave to the next higher low.  Extend the line out to the right to provide a projection of where the next lows could possibly occur.
  4. 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 line provides a  projection for where future wave highs may occur.
  5. Choose atleast 2 -3  points of the higher lows below the price for an uptrend and then join them with a line.
  6. Do the same for the downtrend but this time choose the price tops of the lower highs above the price.  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 and valid it becomes.

How to trade using trendlines in forex?

You can trade using trendlines in forex in 2 ways;

  1. Trading breakouts on trendline.
  2. Trading reversals/bounce on a trendline.

In order to trade trend line breakouts, always wait for a candlestick to close below the trend line or  above.

For example,

After drawing a trendline on a downtrend, wait for a bullish candlestick to close above the trendline after a break.

Similarly do the same if you want to sell after a breakout of a trendline in an uptrend. Wait for a bearish candlestick to close below the trendline after the break.

Trading a trendline 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  trendlines in forex,

  1. First identify the trend direction using a larger time frame
  2. If it is an uptrend, draw an upward trend line connecting 2-3 higher lows (or higher swing lows)
  3. Identify price retracements, that is wait for price to touch the trend line again.
  4. 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.
  5. Place your stop loss 2-5 pips below the low of that candlestick.
  6. Place your profit targets on previous significant lower swing highs that you see on the chart.

You should do the same when trading in a downtrend.  This time you will use the lower highs to draw a trend line.

The GBP/USD, daily chart below shows how to trade bounces on  a trend line in an uptrend.

Trading a breakout

 You can trade a trend line break out in two ways:

  • Aggressive Entry
  • Conservative Entry

The Aggressive way to trade using Trendlines in Forex:

With aggressive trading, you enter a trade as soon as the breaking candlestick gives a confirmation below the trend line for an uptrend. Do the same, above the trend line for a downtrend.

Lets look at an example below;

The chart below shows a break out on a trendline on AUD/CHF, H1 chart.

Entry is as soon as the candlestick closes below the trendline

Conservative entry break out to trade using Trendlines in Forex

For a conservative entry, after a breakout,  first wait  for a price retest.

When price breaks the trendline, it may continue immediately or first hangs around the broken level.

There fore conservative traders wait for the price to bounce back after the break and enter on the second confirmation of the break or bounce.

In this way, you can  reduce risks of run overs or false breaks.

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 the opposite direction, it becomes a false breakout.

False breakouts

A false breakout is when price breaks through the trend line and then goes back to retest and the candle closes above/below 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.

You can avoid false break outs, if you use the conservative way of trading. However, this method may also result to missing out of some good opportunities when price doesn’t retest back.

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.

In summary

  • As you choose to trade using trendlines in forex, you must not forget that;
  •  Trend lines are also traded as support and resistances.  There fore you can use trendlines to generate signals to trade. 
  • For an uptrend, a trend line is drawn below the price movement.
  • In case of a down trend, a trend line is drawn above the price.
  • Trend lines are drawn at an angle and used to determine a trend and to identify signals to trade.
  • 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.

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