Trend is your friend: Forex trendlines

Why is the trend your friend in forex trading？

Top traders will admit that no trading strategy has a 100 percent chance of winning. This statement may seem obvious, but this is exactly why traders need to watch for anything to improve their chances of winning. Trends are one such candidate.

It is important to learn how to trade in an imperfect world. Trend trading is a straightforward way to cover up the flaws in a strategy by identifying the strongest trends in the market. As shown below, a short trade may still be successful even if the trader enters when the market is temporarily rising.

The dominant trend (downwards) is strong enough to turn losers into gainers, depending on where the stops are placed.

The chart below shows that more pips are available when going with the trend than when going against it.

How to determine the trend

To determine the trend, draw a price chart of the selected currency pair containing 100-200 candles. Then answer the question, which direction does price usually move？

If the trend is upward, confirm the direction by looking at a series of higher highs and higher lows on the chart. A valid uptrend should look similar to the chart below.

Notice that each successive high is higher than the previous one, and each low is higher than the previous one.

However, virtually all trends end. Therefore, when a series of lower highs and lower lows form, this uptrend will change to a downtrend. The chart below depicts the point at which traders should look for a trend reversal when the market breaks below a previous low.

If the trend is down, confirm the downtrend by looking for a series of lower highs and lower lows on the chart. Below is a chart of a valid downtrend.

This downtrend changes to an uptrend when a series of higher highs and higher lows begin to form. The image below depicts the trend reversal.

It is important to note that there are no specific rules for identifying highs and lows to use for trend analysis. The idea is to pick the most obvious examples of an uptrend or a downtrend to trade.

Insist on finding a forex pair in such an obvious trend that a ten-year-old child can identify the trend direction from across the room. If you are not sure of the trend direction, then move to the next pair where the identification is obvious.

Using Forex Trendlines

It is often easiest to identify a trend by drawing forex trendlines. Trendlines make it easier to spot areas where the market is likely to bounce off trendline support/resistance, or, break through trendline support/resistance and move in the opposite direction.

The chart below depicts a strong uptrend confirmed by higher highs and higher lows. Drawing a trend line that connects multiple lows in an uptrend and multiple highs in a downtrend is often an easy way to identify the trend from a visual perspective.

The chart reveals levels that the price has respected in the past while moving upwards in the direction of the trend. Bearing this in mind, traders can look for long entries into the market until the uptrend comes to an end.

Learn how to trade with support and resistance levels

Support and resistance are important pillars in trading and most strategies have some type of support/resistance (S/R) analysis built in. Support and resistance tend to form around key areas where price often approaches and then bounces.

Learn how to trade with support and resistance levels

Support and resistance are important pillars in trading and most strategies have some type of support/resistance (S/R) analysis built in. Support and resistance tend to form around key areas where price often approaches and subsequently bounces.

What is Support and Resistance？

Support and resistance is one of the most widely followed technical analysis techniques in the financial markets. It is a straightforward method to analyze a chart quickly to determine three points of interest to a trader:

The direction of the market

Timing an entry into the market

Establishing points to exit the market at either a profit or loss

If a trader can answer the three items above, then they essentially have a trading idea. Identifying levels of support and resistance on a chart can answer those questions for the trader.

Support

Support is an area on a chart that price has dropped to but struggled to break below. The diagram above shows how price drops down to the area of support and subsequently ‘bounces’ sharply from this level.

In theory, support is the price level at which demand (buying power) is strong enough to prevent the price from declining further. The rationale is that, as the price gets closer and closer to support, and becomes cheaper in the process, buyers see a better deal, and are more likely to buy. Sellers become less likely to sell since they are getting a worse deal. In that scenario, demand (buyers) will overcome supply (sellers) and that will prohibit the price from falling below support.

Resistance

Resistance is an area on a chart that the price has risen to but struggled to break above. The diagram above shows how the price rises to the area of resistance and subsequently “bounces” sharply from this level.

Resistance is the price level at which supply (selling power) is strong enough to prevent the price from rising further. The rationale behind this is that as the price gets closer and closer to resistance, and becomes more expensive in the process, sellers are more likely to sell and buyers become less likely to buy. In that scenario, supply (sellers) will overcome demand (buyers) and that will prohibit price from going above resistance.

Top 4 Support and Resistance Trading Strategies

Below are four top strategies for trading with support and resistance:

Range trading

Range trading takes place in the space between support and resistance as traders aim to buy at support and sell at resistance. Think of the area between support and resistance as being a room. Support is the floor and resistance to the ceiling. Ranges tend to appear in sideways trading markets where there is no clear indication of a trend.

Pro Tip – Levels of support and resistance are not always perfect lines. Sometimes prices will bounce off a particular area, rather than a perfect straight line.

Traders need to identify a trading range and therefore, need to identify areas of support and resistance. The area of support and resistance can be identified and is shown in the chart below:

When the market is range-bound, traders tend to look for long entries when the price bounces off support and short entries when the price bounces off resistance.

It is clear to see that price has not always respected the bounds of support and resistance which is why traders should consider setting stops below support when long, and above resistance when going short.

When the price does break out of the defined range, this can either be due to a breakout or a false breakout, also known as a “fakeout”. It is essential to adopt sound risk management to limit downside risk when markets break out of the trading range.

Breakout strategy (pullback)

It is often the case that after a period of directional uncertainty, the price will break out and begin trending. Traders often look for such breakouts below support or above resistance to capitalize on further increasing momentum in one direction. If this momentum is strong enough, it will have the potential to start a new trend.

However, in an attempt to avoid falling into the trap of trading the false breakout, top traders tend to wait for a pullback (towards support or resistance) before committing to a trade.

For example, the chart below shows a strong level of support before sellers pushed the price down below support. Many traders might get carried away and rush to place a short trade prematurely. Instead, traders should wait for the response in the market (buyers attempting to gain control) to break down before executing a short trade.

In the below scenario, traders should wait for the market to continue moving down, after the pullback, before looking for entry points.

Trendline strategy

The trendline strategy utilizes the trendline as either support or resistance. Simply draw a line connecting two or more highs in a downtrend, or two or more lows in an uptrend. In a strong trend, prices will bounce off the trendline and continue to move in the direction of the trend. Therefore, traders should only be looking for entries in the direction of the trend for higher probability trades.

Using Moving averages as support and resistance

Moving averages can double up as dynamic support and resistance. Popular moving averages to include are the 20 and 50-period moving averages, which can be altered slightly to 21 and 55-period moving averages to make use of Fibonacci numbers. It is not uncommon for traders to incorporate the 100 and 200 MAs and ultimately, it is up to the trader to find a setting that they are comfortable with.

From the chart below, it is clear to see that the 55 MAs initially tracks above the market as a line of resistance. The market then bottoms and reverses and the 55 MAs then becomes the dynamic level of support. Traders can use these trendlines to make informed decisions about markets likely to continue trending and those susceptible to a breakout.

Support and Resistance Trading Key Takeaways

Support and resistance a powerful pillars in trading and most strategies have some type of support/resistance analysis built into them.

Support and resistance strategies can either be based on price respecting these levels (range bound strategy) or anticipating the break of support and resistance (Breakout and pullback strategies).

Price will not respect support and resistance forever. Bearing this in mind, traders need to adopt sound risk management to limit losses if there is a breakout.