trend-line-trading

Trend lines are one of the most basic yet very useful tools in analyzing the market.

You not only use it to delineate the general direction of the trend but can also use it to identify high-probability trade setups. 

In this post, we will show you some reliable trend line trading strategies that can improve your trading experience. Keep reading to find out!

 

The Trend-Following Strategy


This is a strategy you can use to catch individual upswings in an uptrend or downswings in a downtrend.

With this strategy, we try to enter a trade in the direction of the trend when a pullback has completed and the price is about to resume the trend. 

 

But we first need to identify the trend and also estimate when a pullback must have ended.

To achieve these, we use the trend lines to delineate the trend and use the support and resistance levels to estimate where a pullback is likely to reverse. 

 Let’s take a look at a chart that can help you understand this strategy:

trend-line-trading

As you can see in that USD/CHF Daily chart, the price is making higher highs and higher lows which shows that there is an uptrend.

Thus, we will only look for buying opportunities, but we have to analyze the chart to know where to look for trade setups.

 The first thing to do is to place the trend line to confirm the slope of the uptrend; we will do so by connecting the major swing points with a line and then extending it to the right. 

 As you can see from that chart, by connecting two lows, we can have a clear and valid upward trend line.

The uptrend line doesn’t only show the slope of the trend, it also acts as an ascending support level.

Notice that when the price pulled back to the trend line, it reversed to start another upswing.

Interestingly, if you look to the left, you will also notice that the level corresponds to a previous resistance level, which has now become a support level since the price pulled back to retest it. 

So, at that level, we have a confluence of two factors:

a trend line and a support level. With that, we know that the likelihood of price reversing from there is high.

 But we don’t just rush to place a trade; we need to see signs that the price is actually about to reverse from that level.

We have that sign when we see a reversal candlestick pattern, such as the hammer, bullish engulfing, or morning star.

So, we wait for any of these candlestick patterns, which will be our trigger to enter a trade.

In this example, our entry trigger is a bullish engulfing pattern, so we can buy at the close of this candlestick pattern; we keep our stop loss below the trend line and place our profit target at a two-to-one reward/risk ratio.

See the chart below:

trend-line-strategies

As you can see, the trade was a winner, as the market hits our profit target. our chances of getting a winner were high because we took a high-probability trade setup.

To recap, a high-probability trade setup requires three important elements:

  • The Trend: an uptrend 
  • A Key Price Level: the trend line + support forming a confluent factor 
  • A signal: an engulfing bar that signaled the end of the pullback/beginning of a new upswing
  • Let’s take a look at another example; this time, a downtrend.

    See the chart below:

    trend-line-trading-startegies

    In the chart above, you can see that the market is in a downtrend, as it is making lower lows and lower highs.

    Our first step will be to identify the swing points on the chart and place our trend line.

    We also attach a horizontal line at a level that initially acted as a support level but turned to a resistance level.

    We take note of the confluence of the downtrend line and the resistance level.

    It shows that the resistance at that level will be strong, so there’s a high likelihood that the price will reverse and resume the downtrend when it rallies to that level. 

    But we don’t just place a short position when the price gets to that level. We wait for a sign that is about to reverse and resume the downtrend.

    That sign will come in the form of a bearish reversal candlestick pattern, such as a bearish pin bar (shooting star), a bearish engulfing bar, or an evening star pattern.

     As you can see, when the price rallied to that resistance level, pulled back to the trend line, a nice bearish pin bar pattern appeared to provide us with a perfect opportunity to short the market.

    To enter this trade, we simply place a market sell order at the close of the pin bar. We place a stop loss above the upper shadow of the pin bar and our profit target at the next major support level or a two-to-one reward/risk ratio.


    The Trend Line Breakout Strategy


    Our second trend line strategy is called the trend line breakout strategy. This is a trend reversal strategy, and it plays out when the price breaks out of a trend line, indicating a change in the trend direction. 

    Let me give you an example. See the chart below:

    trading-with-trend-lines

    As you can see, the market was trending up; by connecting the major swing lows with a straight line, we could get an obvious trend line. 

    The market was respecting this trend line, but after a downward breakout of the trend line, the market reversed. 

    The trend line breakout approach seems to be an easy strategy; however, you should be careful to avoid false breakouts.

    You don’t take a position just because the price broke out of a trend line, as that doesn't guarantee that the trend will change direction.

    So, you need additional confirmation to avoid false breakouts. One of the ways to confirm a breakout is by looking for signs of momentum loss before the breakout.

    Let me give you an example:

    trend-line-trading-breakout

    In the above chart, we can see that the price is on a downtrend and so we draw our trend line by connecting the swing highs.

    Notice that the price was making lower lows as it descended. But the latest price downswing didn’t fall lower than the one preceding it; instead, it stopped around the same level.

    So, we have a double bottom, which is considered a reversal pattern.

    What this means is that sellers failed to push the price lower which is a sign of momentum loss.

    Following this, the price rallied, and instead of reversing around the trend line to continue the downtrend, it broke above the trend line, which further confirms that the trend may be changing direction.

    With these two factors, we can consider this a good opportunity to take a buy position.

    Let's look at another example in the chart below:

    trend-line-breakout-strategies

    As you can see, we spotted an uptrend, so we place a trend line across the rising swing lows.

    Now, look at that chart very well; you will notice that the last upswing in the uptrend didn’t even reach the level of the preceding swing high.

    So, we have a lower swing high (even though we can take it as a double top pattern).

    The price rejection around the same area indicates that there's a strong resistance zone within that area.

    Next, the price declined and broke out below the trend line, which now is a strong indication that the trend is changing direction to the downside because we now have a case of lower swing high and lower swing low.

    At this point, it is a good opportunity to take a sell position.

    We can also use indicators, such as the RSI, to confirm the trend line breakout.

    But first, we need to make a couple of adjustments to the indicator to fit our strategy.

    Go to the indicator settings and add the 50 value: you'll have a single line in the middle that represents it. 

    Here’s how we use the RSI in our strategy: 


  • We take a buy position only if the RSI is above the 50 line when the price breaks above the downtrend line. 
  • We take a sell position only if the RSI is below the 50 line when the price breaks below the uptrend line.
  • Let me give an example. See the chart below:


    trend-line-trading-strategies


    Let’s say that we spotted a downtrend, so we draw our downtrend line. 

    As you can see from the chart, when the price broke above the trend line signaling a possible trend change, the RSI is still below the 50 line.

    So, we decline to take a buy position, as the trend line breakout is not confirmed by the RSI indicator. Expectedly, the trade failed.

    Let me give you another example. See the chart below:

    trend-line-trading

    As you can see in the chart, the market was respecting the downward trend line.

    But eventually, it broke above the trend line, signaling a potential change in the trend direction.

    Notice that the RSI was above the 50 line, which further confirms the change in trend.

     So, we can take it as a good opportunity to take a buy position.

    Look at another example in the chart below:

    trend-line-strategies

    As you can see in the chart, the market was trending up, so a breakout below the trend line indicates a potential trend reversal.

    Notice that when this breakout happened, the RSI indicator was below the 50 line, which confirms that it’s time to go short. 


    Conclusion

    In this post, we have shown you two simple trend line trading strategies that you can use to spot high-probability trades.

    Both strategies work fine if you execute them well. You can learn more of such strategies from our free Telegram channel where we interact and share more knowledge. In the channel, I give out 2 to 3 live Forex signals per week for free.

     

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