Identifying and Trading Trend Lines
Trend lines are one of the most basic technical analysis tools. The are the foundations of any chart patterns and the basis for most chartistic trades. Today we will teach how trend lines are identified and trade, for maximum profits.
What Are Trend Lines
Trend lines are Support and Resistance lines. Unlike traditional Support and Resistance levels which are horizontal, trend lines are sloped - Rising or Falling.
Fig. 1: Support trendlines and Resistance trendlines at the GBP\USD pair
Fig. 2: Support trendlines and Resistance trendlines at the GBP\USD pair
Identifying Trend Lines
We will now describe simple rules for identifying trend lines correctly and quickly. All rules rely on a proper identification of Upswings and Downswings. Upswings are candlestick that are higher than all candles around them. Downswings are candle that are lower than all candles around them.
Fig. 3: Upswings and Downswings at the GBP\USD pair
After upswings and downswings are clearly defined, we proceed to the first rule of identifying Trend lines early: After two consecutive up\down swings are present - connect the two with a trendline.
This rule implies that every two swings are connected with a line. It ensures that you will have the fastest identification of trendlines. Most of the trend lines that you will draw this way will not be valid trendlines, but as price approaches one of these lines and bounces, you will have an advantage over fellow traders as you already expected the bounce and now ready to take the trade.
Make Sure Trend Line is Strong
Here's a tip on making sure the trendline is strong. There is the simple guideline about the number of times price respected the trendline, which I will discuss later. Now I wish to describe a more powerful, less known trick: Demand strong bounces.
The power of trend lines is drawn from their ability to make price bounce when it touches them. The quicker and stronger the bounce, the more powerful the trendline. Many beginners make the mistake of looking only at the upswings and downswings and disregarding the strength of the bounce. I will demand that each time price touched my trendline, it bounced quickly and decisively. If price did not react for several bars before respecting the trendline, it is weaker and I would not trade it. Main Guideline: Make sure that reversal happens at the very next bar after the touch of the trendline.
Number of Touches on Trendline
This is a well-known truth in Technical Analysis: The more times trendline has been touched and respected by price, the stronger it is. The minimal touches for a trendline is two, with trade entered at the 3rd touch (after confirmation).
Fig. 4: Resistance trendline was respected 4 times, hence it is a strong trendline
Fig. 5: Support trendline has been tested for 3 times
How To Trade Trendlines
Trendlines are generally traded like regular Support and Resistance levels, with one difference: When trading trendlines, once must pay attention not only to current trendline, but to its opposite one. Example: If you are trading a support trendline, you should look for the Resistance trendline and find out their relation (Which Chart Pattern they form, etc.). I will now describe the main ways to trade Trendlines.
The simplest, most used technique of trading trendlines. Wait for price to touch a valid trend line (that was tested at least twice), and perform a bounce. Exact entry point is signaled by Japanese Candlestick formations. Read about using candlesticks for entry points here.
Make sure you identify the opposite trend line and look for a chart pattern. Chart Patterns can give you priceless clues on the direction of the breakout, and you should aim at taking bounces only at the general direction of patterns. Moreover, take long bounces only on Ascending Trend lines and short trades only at Descending trend lines. This allows you to always trade with the general trend. The only exception to this rule is the Megaphone, in which we take Aggressive trades against the direction of trendlines.
Fig. 6: Bounce trade on Support trendline.
Fig. 7: Short bounce trade trade on Resistance trendline.
Breakout and Pullback
This is a well-known strategy for trading Support and Resistance levels, and it also applies to Trend lines. Breakout traders attempt to catch new trends after a breakout of a trendline. A famous method of trend line breakout, the Mouteki, uses trend lines as its main trading mechanism. While breakout can be profitable, trading them is hard as there are many 'fakeouts' in intra-day trading. This is way the best way to trade breakouts is simply to wait for price to perform a pullback to the trendline. This is a higher quality trade with much higher probability for success. Read more about Trading Pullbacks here.