One of the most important lessons you will ever learn in forex is to follow the trend. Why fight it? The trend is your friend. It’s like swimming with the current. It’s so much easier than swimming upstream. Embrace it.
The hard part is determining whether you are in a trend or not. The easiest way to do that is by drawing trend lines.
Trend lines are so easy to draw, and yet lots of forex traders still draw them wrong. Read this section carefully and learn to draw trend lines the right way.
Drawing an Uptrend
In an uptrend, the trend line is drawn below the chart. Draw the trend line that connects the lows of the wicks. The trend line becomes a support line, which means that prices are unlikely to break the trend line and will bounce off of it if it touches it again.
Drawing A Downtrend
In a downtrend, the trend line is drawn above the chart. Draw the trend line that connects the highs of the wicks. The trend line becomes a resistance line.
Click here to learn more about support and resistance.
Couple of key points to note here:
• A trend line is always straight.
• The price should touch the trend line at least 3 times to confirm that the trend line is valid. If it only touches twice, it is only a tentative trend line and you can not be sure that a trend actually exists.
• A trend line should not cross any of the wicks. If a trend line is broken, you will have to redraw the trend line.
• A trend line should be approximately 45 degrees. If a trend line is too steep, then it is usually not sustainable. If a trend line is too flat, then it may be a weak trend and can be broken easily.
Here are some examples of how not to draw a trend line:
Common Mistake #1:
If the price of breaks the trend line, that trend line is no longer valid. If the chart continues in the same direction then a new trend line can be drawn as shown in the chart below.
Common Mistake #2:
Sometimes the trend is broken by a significant amount, and a new trend is starting. In this case, you should discard your old trend line completely because it is no longer valid. Do not try to redraw your trend line unless the trend is continuing in the same direction.
Common Mistake #3
Some beginners draw a line through the general direction of the trend. They break all the rules here. If the trend line crosses a lot of wicks, it does not give you any information regarding where the support or resistance level is located.
Determining the Significance of a trend
The importance of the trend line is determined by the number of times the price touch the trend line, and also by the duration of the trend. A trend line where the price bounces off of it 8 times is a lot more significant than one where the price only touches it 3 times. Similarly, a trend that lasts for 3 weeks is a lot more significant than one that lasts for 3 days.
The more significant the trend is, the more reliable it is. You will be able to trade the trend with more confidence. Also, a break in a strong trend line will also be a lot more significant.
Time Frame is Key to Analyzing Trend Lines
Whenever you are drawing trend lines you want to be aware of the bigger picture, and also you want to see what the short term trend is. If you trade on the 4 hour chart, it is necessary for you to examine both the shorter term trend of the 1 hour chart, and also look at the trend in the daily chart.
You may think you are in a downtrend, but realize you are actually in a correction phase of a strong uptrend. If you start shorting because you are only focused on your chart, you will be hurting when the price hits the support level and continue on its uptrend.
Also, analyzing the shorter term trend will give you a good entry and exit signals.
Ignore the big picture at your own peril.
How do I know if a trend is no longer valid?
If the trend line is broken by a significant amount, then your trend line is no longer valid. If your trend line is broken slightly, but then continues in the same direction, then you merely have to draw a new trend line to reflect this. However, if your trend line is broken, and it continues in the opposite direction, you know you have a full blown reversal at your hands.
So how much should a trend line be broken before you know the trend is no longer valid? Unfortunately, there are no hard and fast rules when it comes to determining a reversal. That is why technical analysis is more art than science.
Some longer term traders like to use the 3% rule to determine a broken trend. They require that the trend be broken by at least 3 percent before they decide that the trend is no longer valid. Shorter term traders like to use the 1% rule.
Ultimately it is your decision. Experiment with different indicators and rules to determine which one best fits your strategy.
Do Not Rely Solely on Your Trend Lines
Some people can make buy and sell decisions based solely on looking at trends. However, that is not something I would do. Trend lines are great for determining whether you are in a trend and what stage of a trend you are in, but I would need a lot more information from other indicators before making a buy/sell decision.
Trend lines are merely a tool in your trading toolkit. It is vital that you understand how to draw and analyze them, but use it in the context of your trading system.
Always trade the trend. I can not emphasize this enough. Should I say it again?
Always trade the trend.
Always. This is the easiest way to make money in forex. Find a trend, trade the trend, and ride the trend.
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