3.3 Trends and Trading with Trend Lines in Forex

 
If you looked at the price chart of any market, one thing stands out loud and clear – the prices move in fairly orderly trends, and not in a haphazard or random fashion. The prices may be generally moving up in an uptrend, or may be moving lower in a downtrend. Sometimes they do nothing at all and meander in a sideways trend.
 

Uptrends

 
Price is said to be in an uptrend when successive bottoms are higher than the preceding bottoms, as shown below. Bottom B is higher than bottom A and this sets up the uptrend, which is confirmed only at point C, the third higher bottom.
 
Example of Forex uptrend and trend lines. 
 

Downtrends

 
Price is said to be in a downtrend when successive highs are lower than the preceding highs, as shown below. You can see that point B is lower than point A, and again point C is lower than B. here again, points A and B established the downtrend, but the third point C confirms it.
 
Example of Forex downtrend and trend lines. 
 

Sideways trends

 
Actually speaking Markets are called to be running sideways when there is a lack of an uptrend or downtrend.
 
Example of lack of trend, when market run sideways.
 
 
When prices are ranging or are confined within a band of successively similar tops and bottoms, the market is said to be moving sideways.  See the drawing below.
 

What are trend lines and how to draw those?

 
  • During an uptrend, a trend line is drawn by joining the identifiable support points or support zones.

 

  • During a downtrend, a trend line is drawn by joining the identifiable resistance points or resistance zones.
 

How do trend lines help us in trading?

 
Simple. One can make profits by trading in the direction of the trend until it reverses. So the way to the bank is:
 
  • Find a trend quickly, in its early stages

 

  • Open a trade in the direction of the trend

 

  • Bail out of the trade when the trend reverses

 

  • Repeat the foregoing

 

 

Judging a trend line

 
You can gauge the reliability of a trend line by applying the following tests.
 
  • How many times has it been tested? Generally speaking, the line gets stronger each time it has been tested by the price but not penetrated.

 

  • How long did it hold out? The longer the line held out without being broken, the higher its significance.

 

  • How steep is the line (in other words the angle it makes with the horizontal axis)? The steeper the line, the less reliable it is. 
 

Judging a break of the trend

Illustration of a breakout from a trend line. 
 
How do we know when to bail? Here are the steps that would help you press ‘EJECT’.
 
  • Do prices break through the trend line by more than 3% on a closing basis? If yes, we likely have a break on our hands.

 

  • Confirm with volume. Generally, if volume increases with the penetration, the trend is broken.

 

  • The breakouts offer the opportunities to take a position in the direction of breakouts. In case of upward breakout, the previous resistance may now act as support and in case of downward breakout, the previous support may now turn into resistance.
 

How to trade with trend lines?

Illustration of trading with trend lines during an uptrend. 
 
 
  • During an uptrend, you can enter a buying position when the price comes near the trend line joining the supports zones. Your stop-loss needs to be slightly below the bottom of the support zone.

 

  • During a downtrend, you can enter a short-selling position when the price reaches near the trend line joining the resistance zones. Your stop-loss needs to be slightly above the peak of the resistance zone.

 

  • The parallel trend lines shown in the charts of the in sideways market and uptrend are in fact called channels and will be covered in the next lesson. 
 
The above chart is an example of a perfect parallel channel during an uptrend. Please note that whether it is an uptrend or downtrend the price action may not be within a parallel channel but that does not mean that you cannot trade with trend lines. Do check the following chart as an example.
 
Illustration of trading with trend lines during a downtrend. 

 

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