Success with Trend Lines! (Just Four Questions)

Dec 1, 2014

Drawing a line in the sand and expecting that the waves will never reach that point is the same as drawing a trend line on a chart and expecting a similar thing.

Trend lines in and of themselves are nothing in the market. They are a manifestation of your beliefs of what the market will do. This is why I’ve designed an automated system of my trend lines so that it can help me to remove my bias whenever I look at price on the chart.

However, even with the process of automation on the trend lines drawn I still need to be able to know whether a trend line is tradable.

And just because a trend line meets certain criteria - it may still not be considered tradable

So how do I draw a trend line correctly?

Drawing a trend line is relatively easy and everybody knows how, all you need is a line and at least one point. Hence:

Find one or more points and draw a line

This may mean if you are drawing with a horizontal line that one point on the price chart may suffice - this could be a relative high or low on the active price chart.

Or you could really breakout and venture into the world of sloping trend line by finding TWO points and possibly extending the trend line right and left. You may want to pick two swing points - points that have formed two peaks on the chart for one sloping trend line; and then maybe two trough points on the active chart for another sloping trend line.

The decision on whether these lines are good enough to raise your eyebrow for a trade now depend on what you would decide to call an active trend line:

1. How many touches does the trend line have?

In other words, would you be willing to place a limit or stop entry order on it? In my trend lines I always prefer AT LEAST three trend line touches. Two are needed to create a trend line and a third touch verifies that the trend line is what I would consider to be “active” (or recognised).

The next decision you need to determine once you’ve filtered out your trend lines according to your first criteria above is:

2. What is the slope of the trend line like?

In my experience the flatter the trend line the better. Trend lines that are too sharp are merely defining the angle of the active move and any price movement beyond this sharp move would only be telling me that price is no longer moving at this rate (it could be having a rest).

Whereas flat trend lines show that price isn’t moving beyond a point and breaking out of this direction would mean that the sideways trend is no longer occurring - i.e. there has been a CHANGE OF TREND.

So you may want to begin filtering out trend lines that are too sharply sloped.

3. How far has price burst through this trend line?

Ideally when trading breakouts beyond trend lines you don’t want price to have previously CLOSED above (or below). If price has shown to have closed above the trend line previously you may have to wait for price to close further above (or below) than what it was previously.

I am really stringent with this criteria for filtering out my current list of active trend lines. In fact, I’ve gone so far as to go back to when the trend line was first formed to check that price hasn’t burst the trend line even with it’s high or low price too much. I want the market to show me how responsive it is to the trend line, however, I need to be also mindful of the fact that when the market is volatile I need to be somewhat lenient on this “bursting criteria” as the market may still be responding to the trend line, but the volatility is overriding.

You may find that by similarly being strict in this area of looking for trend lines to trade you too may improve your profitability.

4. How long has the trend line been active?

Trend lines can be drawn as far back as the beginning of the first price point, whether or not that price point is relevant today will remain to be seen. Generally though trend lines that span only a few minutes will not be as popular as those that have been active for decades. The longer a trend line has been active (by the time it gets to this 4th gate) the more important it becomes.

I know that I’m not the only currency blog in the entire world. There are thousands of similar opinions floating around the world today and even more so. What makes a trend line popular is whether people are watching it AND are prepared to take action upon it with their money. This can present either a good trading opportunity or you may like to take a contrarian approach and fade the popular market opinion.

Again trend line trading presents this opportunity for all traders depending upon their personality and risk profile.

Begin to ask yourself these four questions every time you look at a trend line to trade. Write the answers for each of the four questions so that you can begin to determine what type of trend lines resonate best with your trading. Take snapshots of the charts and continue to build up your portfolio of trend lines.

The more you begin to train yourself in seeing opportunities the better you’ll become at utilising this popular trading technique that most price actions always default to when they analyse the market.

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