Trend line trading is an absolute fantastic tool to use to outline the boundaries of a trend and potentially catching trend reversals. In the world of technical analysis, learning how to draw a trend line is a necessary skill to acquire if you want to be able to project the trends in almost any asset class such as stocks, commodities, Forex and cryptocurrencies.
The job of this particular trendline trading strategy is to both join the trend and ride it out all the way to the end or to catch a trend reversal. To maximize your potential profits there are few trading tricks that we’re going to reveal throughout this trading guide.
Mastering trend lines can be an easy process once you have the right mindset and you know what price feature to look for. Many retail traders fail to utilize trend lines to their full potential and are not aware how powerful such a simple technical tool can be.
Trend lines are very versatile tools that can be used beyond trend trading. You can take advantage of the power of the trend lines even if you’re a day trader, swing trader or even position trader.
If you came here to find the Holy Grail of trading we might disappoint you. That’s not what this trading guide is. If you came looking for that you’re probably a Forex losing trader and you probably always going to be a losing Forex trader because you’re not worried about core trading concepts.
You’re worried about chasing rainbows.
What you will learn here is far more important, so if you’re not chasing the Holy Grail of trading you may want to continue reading forward.
Moving forward into the first step we need to learn how to draw a trend line the proper way and build the foundation of the trendline trading strategy.
How to Draw a Trend Line
Let’s start by looking at how the price of any market really moves.
In practice, the market will never go in a straight line up or down. But rather it will have a number of swings until eventually it reaches a climax point from where it reverses the prevailing trend.
A trend line can helps us have a better picture of the price action and a better understanding of what goes in the market. We can name at least three applicability of the trend line as follows:
- Identify possible dynamic support and resistance levels.
- Defining the market trend.
- Pointing out trend reversal.
To draw a trend line, either in an uptrend or downtrend you need at least two swing points that can be connected with a straight line. The job of the trendline strategy is to join those swings in the direction they are moving.
Important note: we prefer to draw a trend line using three points as it has more weight and it’s a more reliable method to gauge the price action.
In an uptrend, when you draw trend lines you can only draw trend lines from the bottom. Conversely, in a downtrend, when you draw trend line you can only draw them from the top.
The second rule you need to remember when drawing trend lines is that the first point of reference used to draw the trendline is always the lowest point of the prevailing uptrend – this is the case of an upward trendline. Conversely, for a downward trendline the first point of reference used to draw the trendline is always the highest point of the prevailing downtrend.
You can still continue applying the same rule when joining the following swing points and connect the candle wicks. However, you can also use the lowest point of the candle’s body within that swing. Or in other words the closing price.
Moving forward, to make things simple, we’re going to refer only to the case of drawing a trend line in an uptrend.
In an uptrend, the trend line indicates an area of support that has the potential to generate buying opportunities.
We’re going to explain in deeper details the importance of using the closing price to draw trend lines as we progress through this trend line trading guide
It’s crucial that you allow yourself to also use the closing price so you don’t miss out trades
Trend-line Trading Strategy
We’re going to share a secret method to use trend lines to identify potential tops and bottoms in the market. This is an unorthodox way to make money with trend lines that we have discovered over many years of trading and perfected it through a trial and error process.
Before giving out the secret sauce, we need first to define one important component that makes the trend line strategy work.
The preferred time frame used for the trendline trading strategy is the 1-hour time frame and the 15-minutes chart. One reason why we preferred these specific time frames is because of the behavior the price action exhibits on intraday time frames.
In the forex market, the intraday time frames are separate by the different trading sessions. In this regard, the interaction between the supply and demand forces exhibits a repetitive pattern that can be framed by using trend lines.
This brings us to a very important rule of the trendline trading strategy. The closer the price action gets glued to the trend line, the more important it becomes.
Here is a great example of a trend line that has the price action glued to it:
A trend line that has lots of touches will always be considered more important when trading trend reversals.
Let’s now put everything together in a mechanical trading strategy that you can follow to grab profits from the market on a consistent basis.
See below:
Step #1: Draw Trend Line by Connecting the Closing Prices
To simplify this process you can always switch to the line chart. But, when switching to the line chart makes sure it’s based on the closing price.
It’s very rare and hard to find trend line that fit perfectly with every high and low. And to a certain extent, we can say the same for the case of using the closing price. They don’t line up perfectly with the trend line either.
Let’s take a look at an example:
What makes the closing price more special is the fact that it’s the body of the candle that encapsulates most of the buying and selling activity. The wicks or the shadows of the candle only represent a thinly portion of the smart money activity that we can ignore.
When using trend lines we want to focus on what the big money are doing and gauge the price action only based on their activities.
What’s important here is to simply ignore the wicks.
See chart below:
This brings us to the second rule of this reversal trading strategy.
Step #2: Make Sure the Price stays glued to the Trend Line
The most important part of this reversal trading strategy that determines the weakness of the trend and signals a potential reversal is the following price characteristic.
As promised, we’re going to reveal the secret that we use to forecast trend reversal with a high degree of accuracy. However this secret is made up of three essential parts that we’re going to mention in the following steps.
The first price feature you need to be able to spot is for the price to grind higher close to the trend line. So what happens is that the trend line acts as a magnet that keeps the price glued to it. From a technical perspective, the price needs to move slowly and surely to the upside.
Below is an example of a market that stays glued to the trend line. What’s important is that a relevant trend line needs to get the most touches possible. These multiple touches will make the trend line weaker and make it possible for a trend line breakout.
Let’s take a look at the example below:
At this point we only reveled one part of the secret.
Moving forward, we’re going to bring to light the next price feature that you need to be able to spot on the price chart.
Step #3: The price needs to depart higher from the Trend Line
If in the previous step we looked for the price action to be glued to the trend line, now we’re looking for the price to deviate from the trend line and move higher. However, what is important here is to see the volatility jump higher. We need a swift and sudden move to the upside.
We need to be very careful when examining the price action and only consider trading those price setups that adhere to the rules.
The second feature of our trading setup is this price departure from the trend line.
See chart below:
From our own experience market tops always develop when we see a surge in volatility. The sudden surge in price leaves behind price inefficiencies that later need to be filled in which brings us to the third price feature of our trend line trading setup.
Step #4: Look for the price to reverse and eventually break below the Trend line.
The sudden rally is actually setting the stage for our reversal pattern. This fake rally also misleads many of the novice traders to get into the market and buy which makes the reversal pattern possible.
Notice how shortly after the price left the trend line, the market came back to retest it and eventually produce a trend reversal.
See the price chart below:
This is a perfect example of a trend reversal identified by using the magic of the trend lines.
However, a reversal is only confirmed once the trend line is broken. So our entry strategy is to wait for a break of the trend line before we enter the market. You can wait for a break and close below the trend line before entering the market but we found it to be unnecessary. This only leads to leaving more profits on the table.
What we like to do is to add the RSI momentum indicator in order to add an extra layer of confirmation that the momentum is continue to rise while we draw the trend line.
In this particular example our target would be the starting point of the trend line or the last swing low. Our second exit strategy is to use a more dynamic profit target.
Simply measure the depth of the rally by counting the numbers of pips from the trend line to the highest point of the rally. To get your profit target, project to the downside the same amount of pips starting from the breakout point.
Conclusion – Trend Line Trading
One of the main mistakes many traders do is trying to force a trend line fit a trend. If it doesn’t fit the price action this is a clear indication that the trend line doesn’t have any relevance and power. This reversal strategy only works as long as the market continues to respect all the rules outlined throughout this trading guide.
We hope this reversal trading strategy has given you a clear understanding on how you can take advantage of trend line by using an unconventional approach. You need to be unique in this market if you want to survive in the long term.
If you don’t use trend lines or at least understand them you have a very slim chance to properly define the boundaries of a trend. We can guarantee that every top trader out there is not ashamed of using simple tools. So, you shouldn’t be fooled by the simplicity of trend line trading, but instead make use to the fullest potential.
Thank you for reading!
-The Team @ TMP