Lesson 3 - Tools of Strategy, TRENDLINES

Introduction

     Trendlines are probably the very first tool of technical analysis. Almost every trader use trendlines as a basic method of predicting rebounces and reverse points. The best thing in it this is really simple and can give you really nice and accurate signals if used properly, but also have to tell that trendlines are really subjective, every trader draws his\her trendline at a different place.

     A trend line is formed when you can draw a diagonal line between two or more points, implicitly, the more points, the more reliable the trendlines is (channels are based same). Don't underestimate the power of trendlines, trading them can be the same profitable.

Okay, but how to draw a proper trendline / channel?

     There is no proper trendline. Just try to be as neutral you can, and draw firstly what your eyes get caught on. Drawing a trendline can be really different from trader to trader, some pay attention to the shadow of candlesticks, some don't, and some mix these things. Personally, I am a mixer.

A simple upward trendline. In an upward trend, trendlines must be BELOW candlesticks.

A simple upward channel. @ MetaTrader: double click on a trendline, CTRL+C, and drag the trendline, now you have two parallel trendlines which create a channel.

How do I read the signals?

    Everytime price touches an upward trendline (with at least two major lows connected) a long position should be opened. Everytime price touches a downward trendline (with at least two highs connected) a short position should be opened.

A simple upward trendline. Buy on dips.

A simple downward trendline. Sell on rallies.

    It's really important to note that these are only examples, what happened in the past. Real-time, it's hard to find proper trendlines and nice like the above. It's a way more easier to explain on past charts, just don't forget, that real-time you can draw a lot of false trendlines, which will come lightly only after the trendline is broken. Above pictures are just examples.

A channel setup. Sell on rallies, buy on dips.

Trendlines on ranging. Also a pullback trade presentation.

How do I manage positions based on trendlines?

     Although all the pictures states trades on REBOUNCES/TOUCHES, I don't take those trades. To understand the system, you had to have a basic knowledge of trendlines that's why I wrote the above which is a bit unrelated because not playing a part of the system. So to continue, I am playing only on breaks, not touches.

     Assume there is a trend: downward. Counter-trends always form (upward), and I enter at the break of these. Example:

If its a ranging zone:

    I put all stoploss at the middle, at 1/3, or at 2/3. It depends on the actual situation (based on how much traffic is ahead). Never use a fixed stoploss in pips!

If its an upward/downward trendline/channel:

    I put all stoploss at the high + 10 pips (sometimes more) above the candle which broke the trendline.

In both cases I don't put takeprofit, but I always modify my stoploss to secure more and more profit. Don't forget, it's a trendfollower system and we can never know when a trend ends.

Have a question?

    Don't hesitate, ask at comments section!

(Written by Stockwalker, 15^th of June 2011)