Markets move in trends. This conclusion was made from the Dow Theory. In the late 19th century, Charles Dow, known for the Dow Jones Industrial Average index, developed different methods to analyze financial markets. These methods were named the Dow Theory.
A trendline is among the things every trader begins with before learning technical indicators. They are used to frame trends and determine the points where the price is more likely to turn around. In this article, you will find the fundamentals of tradelines, including the best trendline trading strategies and the best tools to combine trendlines with.
What are trendlines?
A trendline is a line that connects at least two highs or two lows to shape a market trend. It can be angled or horizontal depending on the current trend. In a downtrend, the trendline will go through falling highs and lows. In an uptrend, it will go through rising peaks and troughs. In a sideways trend, it will connect highs and lows set at the same level.
It’s used as a support or resistance level. The probability that the price will rebound from the trendline depends on the timeframe you use. In shorter periods, the price changes its direction more often. Therefore, if it rebounded from the trendline twice, there is a high risk that it will turn around soon. In a solid trend on the longer-term timeframes, it’s more likely that the price will rebound from the trendline more than three times.
Trendlines are often used in pairs so that you get a channel with potential entry and exit points. A trendline tool is presented on any trading platform and can be used on any timeframe.
Price bounce strategy
Step 1: Enter the market
You need to draw two trendlines so that they form a channel. Set a buy order at the support level or a sell order at the resistance level.
Step 2: Set a take-profit order
The take-profit target will be placed on a resistance level in a buy trade and on a support level in a sell trade. If you are sure the trend is solid, you don’t have to close your position at the first point from which the price will rebound. You can prolong the trendline and find the second point where the price may go after it moves within a channel for a while.
Step 3: Place a stop-loss order
To minimize risks, you should always place stop-loss orders. Its location will depend on price volatility. Determine how far the price may go beyond the support/resistance level based on its recent fluctuations or apply the risk/reward ratio so that your potential returns are much bigger than a potential loss.
A breakout strategy
Another trendline trading strategy is a breakout. The price may not rebound, instead breaking beyond the support/resistance level to either change or continue the existing trend.
Step 1: Enter the market
Open a position only after the price breaks the trendline. As there is a risk of a fakeout, you must be sure the price will keep moving in the breakout’s direction. Use the volume indicator that reflects the strength of market participants. If the volume is weak, there is a high risk that the price will return to the channel. You can also use convergence/divergence, which always reflects a trend change.
Step 2: Determine a take-profit level.
The take-profit level can be placed on the next support level in a short trade and on the next resistance level in a long trend.
Step 3: Limit potential losses
To limit potential losses in case of a fakeout, you should place a stop-loss order on the level the price has broken beyond.
Trendline trading strategy: secrets revealed
Signals of any indicator, pattern, and tool you use for trading must be confirmed by another indicator, pattern, or tool. The signals must be provided when the price is near the support/resistance level.
To use the trendlines successfully, you need to validate price movements with indicators that reflect a price rebound (for instance, RSI, MACD, Stochastic, or Awesome Oscillator) or those that confirm a breakout (for instance, the volume indicator or convergence/divergence based on the indicators above). Also, you can find a candlestick pattern that reflects a price reversal.
Trendline trading doesn’t require advanced skills. If you practice a little on historical data or a demo account, you will understand trendlines. If you already know how support and resistance levels work, you can immediately implement the strategies mentioned above.