Justin is an active trader with more than 20-years of industry experience. He has worked at big banks and hedge funds including Citigroup, D. E. Shaw and Millennium Capital Management.
Trendline trading strategies are one of the most simple and powerful trading signals in the market. Using a graphical representation of price, and indeed other metrics including trading volumes, can help traders spot major signal posts in the market. Trendline indicators are so commonly known and used that the market can literally turn as and when a trendline breaks. Using them allows traders and investors to consider market direction over a multitude of timeframes and take an opinion on how long price momentum might hold up.
In this article, we’ll use real-life trade examples to look through:
The starting point for trendline strategies is a chart showing price data over a period of time. The price action will rarely be in a straight line, but there could be moments when price appears to rise or fall to keep in line with the general direction of travel. These price trends can be studied using the freely available charting tools found at all good brokers.
Trendlines that have a specific and identifiable trajectory can be drawn by connecting high or low price points that appear over time. These lines then form levels of support or resistance and identify the price levels where the forces of supply and demand compete to determine whether a trend is going to continue or fail.
The above chart of the China A50 stock index covers the period 2012 to 2021. The trendline represented by points A, B and C represents support for the index when price reaches a certain point.
Trendlines don’t all point upwards. The below example of gold shows bearish price action during the time period August to September 2021.
Also note how price breaks the downward trendline during the time period marked in yellow. While the break is undeniable, one interesting feature of trendlines is that they can continue to be useful. When price breaks back through the trendline to the downside, the trendline continues to be an effective visual guide. Supporting trendlines that are broken can then become points of resistance, and vice versa.
Price action can be guided by support and resistance trendlines at the same time. The below bearish move in forex pair GBPUSD illustrated price being channelled downwards in a descending wedge pattern formed by the fact that the two lines are converging.
Part of the simplicity of trendline strategies is that when price action moves towards a trendline, there are two possible outcomes:
The binary nature of the possible outcomes makes trendlines relatively easy to trade. In their simplest form, price does or doesn’t bounce/break.
Strategies that use trendline bounces take the signal as there is no need to exit a winning strategy.
Strategies that focus on trendline breaks are based on the idea that the breakout could be the start of a new trend, and getting into trends early is always a good idea. Breaks therefore benefit from two different market moves. The first group is those who are in positions bailing out of them – those traders who were hoping for a bounce but are disappointed. The second group is made up of those who are not in a position deciding to act and get into one. At the time of a trendline break, both of these groups of traders will be trading in the same direction, which is why trendline breaks can be associated with strong subsequent price moves.
There is also the potential to use the trendline to set a tight stop loss, meaning that if a trendline break strategy doesn’t work out, then at least losses will be minimised. In the above example of the Bitcoin market, once price breaks through T2, a stop loss set above that price level would not have been triggered. After the break to the downside, the line T2 then successfully acts as resistance.
The same principle can be applied on a trendline bounce strategy. Using the trendline bounce as a buy signal instils some discipline into the decision-making process. The patient approach means that price entry point is optimised, and a stop loss can be applied that is just below the trendline. This trade entry point uses a strong trading signal to enter a position with a good risk-reward profile. In the example, the stop loss is set at 2% below the value of the index at entry, but the subsequent price rally represents a +15% gain and one that is still continuing and trading above the supporting trendline.
Below are some standard techniques used for trading trendline strategies that are worth practicing using in a demo account.
Stop Losses and Take Profits in Upward-Trending Markets:
Stop Losses and Take Profits in Downward-Trending Markets:
Purists are of the opinion that three touches are required before a line is confirmed, but there are many ways of approaching the topic.
The answer to this question involves using trendlines on metrics other than price. The below chart incorporates volume as well as price data. The start of the price moves from A, to B, to C is marked by an uptick in trading volume. This is a sign that the move is well supported. Buyers and sellers are coming into the market in large numbers, as demonstrated by high volumes, and it is buyers who are prevailing, as demonstrated by price.
After points Y and Z, trading volumes drop off, as demonstrated by the trendline on the right-hand side of the chart. There’s no reason why EURUSD can’t come back to life, but at the moment, the lack of activity is also being matched by sideways price action. Those looking to spot and trade the next trend may need to be patient if studying EURUSD in the near future.
Trendline strategies are great for providing a clearer and intuitive understanding of market momentum. They offer tight stop losses and clear trade entry and exit points, but all indicators benefit from being used in conjunction with others. Whether your trading style is based on day trading, swing trading or trend following, incorporating signals from the below is always a good idea. What is additionally useful is that all of the below can work on different time-lines, from intra-day to monthly, which is similar to the way that trendlines can work.
Trendline candles make charts more readable and trends easier to analyse. Developing trend-spotting skills is a key ingredient to successful trading, and using trendlines helps traders to go with the flow rather than against it. It can’t be guaranteed that future price moves will carry on in the same direction, but the trendline approach tilts the scales in the right direction.
It’s possible to use trendlines to place trades with precise entry and exit points and the charting tools used are freely available at good broking platforms. Whether you’re using a demo or live account, incorporating trendlines into your analysis is an ideal way to start picking up on the mood and direction of the market.
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