Why Do Horizontal Trend Lines Work?

May 10, 2014

Whenever you use an indicator or a trend line in your trading or analysis it’s always good to challenge your presuppositions. Many traders love an indicator because it looks nice or appeals to their taste, which may be a great way to start in trading, but unless your indicator or analytical tool is grounded in something that makes sense you may find its effect short-lived.

One of my favourite analytical tools has been trend lines, with horizontal trend lines being my most favoured of all. And why I know that not every horizontal trend line will come off just perfectly it does then beg me to approach the question: why would/should horizontal trend lines work in the forex market (or for any market for that matter)?

My answer to this question comes from experience - not just forex trading experience (which is a great confirmation to the tool), but to other working experiences outside of trading.

I remember most vividly when working for my father’s small business how we had several large orders to fulfil in China for a client for the purchase of tank containers (the client was a mining company). As we both didn’t know much about the foreign exchange market whenever the suppliers invoice came in (being denominated in USD) we would transfer the funds through our bank and have the invoice paid.

No doubt my father’s small business was not the only business in Australia, let alone the world which would do likewise.

As the business began to grow we needed to place larger orders with our supplier in China and soon we began searching for ways to improve the service. Soon we began finding better foreign exchange providers, such as OzForex, and we even began watching that segment on the news that we never used to pay attention to: the finance section!

Interestingly, during this time we would often tell each other that we would transfer our money to our supplier once the AUDUSD price “got back to where it was last week” and I found that by keeping an ear and eye to the ground on how prices were moving we could make a few extra bucks on the side.

So the concept of trading around horizontal prices was a very real and tangible concept in my father’s small business. We would talk about the price mentioned on the news and speak on it’s relation to whether it was higher than normal or lower than normal - on whether we should transfer our funds now, or wait another few days. We never spoke on the AUDUSD decreasing at a rate of 5 pips per day, or anything like that and this is why I seriously believe that horizontal price is a tangible tool that is tradeable in the markets.

Firstly, when “normal” business people speak on currencies they never speak on the rate at which a currency is moving, or what the moving average is, or where the Stochastic Oscillator is at, or whether the price is overbought or oversold - the only thing sticking in the minds of these busy people is that “high price” they saw on the news a few days ago, or that “low price” they saw. That’s it.

Now I certainly understand that the foreign exchange market is NOT run solely by small business owners decisions, but unless businesses have someone who’s dedicated to watch the forex movements to help improve the company’s bottom line then the scenario I’ve seen would be played out by many other businesses around the world. Now I also understand that banks who receive these orders from small businesses may similarly “hold” and play with their funds to make more money, but if a bank knows that they can’t their not likely to play with it and to process it as soon as possible.

So if there are thousands of these types of transactions happening just the small country of Australia think of what’s going through the minds of the myriad of other business owners and employees who just don’t have the time to watch charts. They’re going to place their order according to prices they’ve heard or read from the news wire and if price is currently around that then they’re going to action a transaction.

This is why I believe horizontal charts just work. Ordinary busy people find it much easier remembering a price and within their role in their company if they’re responsible for transferring funds they’re going to action this when they see that “high” or “low” price. Easy. And done. I’ve seen it in my father’s business and I’m sure others have seen it too.

I love horizontal trend lines. Maybe you should look at it too.

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