Trendline strategies are great for providing a clearer and intuitive understanding of market momentum. They offer tight stop losses and clear trade entry and exit points, but all indicators benefit from being used in conjunction with others. Whether your trading style is based on day trading, swing trading or trend following, incorporating signals from the below is always a good idea. What is additionally useful is that all of the below can work on different time-lines, from intra-day to monthly, which is similar to the way that trendlines can work.
This article is a step by step guide on how to trade TD line breakouts and use risk management to generate a profitable trading strategy. DeMark believes that supply and demand dictate price action. When demand exceeds supply, prices will advance and conversely when supply exceeds demand prices will fall.
In addition to using the close to designate a breakout or breakdown, there is a setup that allows you to determine that intra-day pricing is breaking out. If the close of the asset you are trading is down on the day prior to an upside breakout, intra-day breakout could be considered viable trigger. If the close on the day prior is up for a TD break down, and intra-day breakdown could be considered a viable trigger.
In subsequent years following the first publication of the book in 1994, there have been many other projection guides. One such guide is to use a specific percentage. For example, if you plan to risk 2%, the reward you should expect from a TD breakout or breakdown should be 2%. The idea is that you will win more than you lose when using the TD strategy.
You would win 71% of the time (win 5, lose 2) if you risked 2%, to make 2%, using the close of the trading session to confirm the TD breakout. In many cases the TD signals appear to work more efficiently if you provide the trend to develop. This means short-term trading with tight stops could be unsuccessful. Using the TD trend line breakout for daily closes, if preferred.
Reversal trading is a safe trading strategy. Support and resistance levels are in play, until they are broken. For this reason, many traders like to trust them by trading reversals rather than breakouts.
One of the most common mistakes regarding trading with trendlines is to trade on an unconfirmed trendline which connects only two points of the price. As a rule of thumb, the more times the price has touched the trendline in the past, the more important the trendline becomes.
Besides trading bounces off a trendline, you can also look to trade breakouts above a falling trendline and below a rising trendline. These breakout trades are usually followed by a large trading momentum in the direction of the breakout, which makes them a popular trading approach among day traders.
Almost all trendlines that you apply to a chart will occasionally have fake breakouts. The key is to connect as many higher lows (or lower highs) as possible, and leaving the fake breakouts outside the trendline.
When trading fake breakouts, you have to wait for the price to actually reverse inside the trendline. Those candlesticks that form fake breakouts often have long upper or lower wicks, signaling that sellers (buyers) are joining the market and pushing the price back inside the trendline. This is a powerful price-action signal to enter in the direction of the trend.
Once you apply a trendline based on at least three touches of the price, leave it as it is until it gets broken. Any failure by the price to break a trendline should be considered a fake breakout (which, by the way, can be a great trading opportunity.)
A strong uptrend rising at a 70-degree angle soon becomes heavily overbought, which means that traders would be better off trading a breakout to the downside than joining the trend at a possible peak.
Breakout traders consist of three parts: spotting the breakout, entering the trade, and closing at the correct moment. Spotting breakouts is the key element and is done by identifying consolidated ranges formed when a price is trading within levels of support and resistance.
Planning your exit is just as crucial as your entry when it comes to profiting from breakout trading. Before you open your position, you should look to establish a reasonable profit objective and set stop and limits appropriately.
A prime example is the European Opening Range breakout strategy. Here, you would focus on EUR/USD, or any European major, at the start of the London, or European, trading session. Learn more about the European Opening Range strategy and view examples.
Sometimes the price of a security can momentarily break through a support or resistance level, only to fall or rise back into the channel it was previously trading in. This is known as a false or failed breakout and often occurs when traders misidentify levels of support and resistance.
Unfortunately, you can only identify a breakout as false once it moves back into its original range, which makes stop-loss orders critical to breakout trading. As mentioned in the exits section, setting a stop-loss order at the level of support or resistance involved in the breakout will protect you from running up losses in the event of a false breakout.
This strategy can be precisely described on a daily chart as it's probably the most useful chart of all that delivers a good number of pips, and at the same time captures the essence of a trendline break within the context of a secondary trend.
The key element of the strategy is to spot a situation on the charts where a trendline can be used to connect the highs of the price candles when the market is trending downwards, or the lows of the price candles in an uptrending market. Once these areas are defined using the line tool to trace at least three highs or lows, the trader looks for price to break the trendline. This trendline break signals a period when prices will move transiently in the opposite direction.
B. This is the fanned trend line in the down trend. You can see at the green circle that price broke the trend line to the upside, reversed and tested the approximate trend line area before taking off to the upside. This is known as a trend line retest and is quite common with not only trend line breaks but also any breakouts plus support and resistance trading.
Veteran traders will agree that trendline trading forms an integral part of their trading system. Novice traders appreciate them due to their simplicity of drawing the trendlines, effectiveness to reflect the underlying price trends, the reflection of trend strength, and ability to confirm trend reversals. While trendlines can be traded independently, they also form the basis for a wide variety of other technical forex trading strategies.
The above picture shows a GBPUSD M30 chart, the prices following an uptrend line. The trader uses the first 2 swing points to construct the trendline, upon the construction of the trendline most traders will prepare a trading plan and would wait for the prices to fall back and retouch the trendline again. Since the trader anticipates the prices to continue the trend, they place a Buy limit order 5 pips below the trendline, this will result in a trade with the best possible entry price.
There is a possibility, the momentum of the prices may carry the prices and breach the trendlines momentarily and then retrace back again to continue in the direction of the trend. These price movements are identified as false breaks, false breaks should be inspected and validated using price action trading.
Picture H illustrates a trendline breakout trading. Once swing low A and swing B are connected a trendline is formed. At point C the price breaches the trendline lower and the candle makes a closing price lower than the trendline. This is further validated by the next candle by opening and closing below the trendline.
The up trendline was acting as a support for the trend, once the trend line is broken this transforms as resistance and acts as a downtrend line. Now the trader has new information and will prepare a trading plan to enter the markets in the direction of the newly formed trend. Best traders wait for the best prices to enter, they avoid entering the markets at any given price level to ride a trend.
Market structure and price momentum during sustained price pressure particularly during an economic news release may create price spikes and may result in candles closing the opposite side of the trendlines. These scenarios may warrant the trader to place a trade believing the change in direction of a trend, though they may last momentarily. Identifying false breakouts are an important part of identifying price reversals and form an integral part of trend line trading, many traders seem to ignore additional confirmation using price action.
Almost all traders would have constructed a trendline for one reason or other during their trading. The simplicity makes it a handy tool for everyday use, it is of no doubt that trendline is a friend of the trend. Trendline trading strategies if used carefully and properly in confluence with price action will result in a successful and rewarding trading strategy.
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