If there was a technical analysis university, trend lines would be taught to students in TA 101! Any technical trader should be able to identify the underlying trend and know how to draw trend lines to take advantages of the dips in price.
Regardless of how menial it sounds, often people face a hard time drawing trend lines properly. Perhaps because, most Forex instruments (the currency pairs) trend only 10-20% of the time. Greenhorn traders often end up drawing trend lines of a ranging market then beat themselves up in flames, convinced trend lines don’t work!
The key to drawing trend lines is finding a time frame where market is ranging up or down, AKA trending. Seasoned traders first use various trend following technical indicators to identify, if the market is trending, then they to spend time drawing a trend line. On the other hand, tyro traders first try to draw trend lines and then try to find out if the market is trending or not. See the difference?
We will discuss about identifying a proper trend some other time. First, let us get started with drawing a trend line on a chart of a market that you have already acknowledged as a trending market.
Let us presume that you have identified the downward move on this GBPAUD Daily chart. Initially, just connect Point A to Point B using the “Trendline tool” of your charting platform. With this, you will find two short entries as the price try to penetrate the trend line you have just drawn. The AB trend line will become invalid the moment price has closed above the line (the candlestick prior to C). Professional traders will close any short positions that they had at this point.
However, you shouldn’t simply take an opposite long trade just yet. Trends are called trends, because they are based on market bias. It takes considerable fundamental paradigm shift to change a trend, not just because your trend line had a price penetration. This is where most novice traders fall victim of false breakouts.
Professional traders often wait for the price to retrace then draw another trend line on the primary trend, which is down on our example above. Once you have identified a retracement, with Fibonacci or any other tool, draw another trend line connecting A to C. Then sit tight and wait for price to reach back to the AC line.
Next, on the day labeled as D, price penetrates AC line but failed to close above the trend line. If you are an aggressive trader, you can go short at the moment price touched your trend line. However, moderate traders with low risk appetite will wait for the trading day to end for a confirmation.
Regardless how you define your risk, trend line is a great tool for calculating and minimizing your stop loss levels. But the key aspect of using trend line is that It keeps you focused on finding trading opportunities with the trend and prevents you from taking counter-trend opportunities.