Hello traders! This week’s newsletter comes to you from sunny southern California where I’m teaching a futures class. Today we talked about trendlines, so guess what this week’s letter is about?
In the world of trading, trendlines actually have many uses. For example, you can use them to help define a trend, be it up or down; you can use them to help with trade management, meaning, staying in a trade; you can also use them to help you decide when to get into a trade. Let’s explore these, shall we?
How to Use Trendline to Define a Trend
First of all, way back when you were in second grade and your teacher was showing you how to draw a line, how many points did you need to draw that first line? If you answered 2, congratulations you got it right. However, in the world of trading we need to add a little extra. In trading, we will draw an upward sloping trendline off of two swing lows on the chart, and a downward sloping trend line off of two swing highs on a chart.
On this AUDUSD 15-minute chart, I’ve drawn in a down trendline off of the highs marked 1, 2, 3, 4 and 5. I’ve also drawn in an up trendline off of the lows marked 6, 7, 8 and 9. Now, the EARLIEST I could have drawn in the down trendline is at point 2. Remember, it takes two points to DRAW the line. However, in trading we need at least one more touch of the trendline to CONFIRM that the trendline is valid – meaning that someone with more money than us is drawing in the same trendline and trading off of it. As you can see, price bounced off this trendline at points 3, 4 and 5, confirming that this was a tradable line.
It’s the same but the opposite with an up trendline. The earliest we could have drawn in this line is at point 7, with points 8 and 9 confirming this trendline. There are numerous other potential trendlines on this chart, I hope with a little practice you will be able to spot them in seconds!
Earlier in the newsletter it was mentioned that we can use trendlines for several different things in trading. The first was defining the trend. As long as price is below a downward sloping trendline, we can say the trend is down and we should look for short trades; if price is above an upward sloping trendline, we can say the trend is up and we should look for long trades. Simple enough.
How to Use Trendlines to Keep You in a Trade
The next previously mentioned use for trendlines is a bit trickier. How can we use them to keep us in a trade? In this 480 minute chart of the EURUSD, you could have gone long in the demand zone at the blue arrow. Part of your trade could have been exited at the supply zone where the green arrow is located. But haven’t we heard that “letting our winners run” is how to make the big money? Of course we have. Now, as long as price stays ABOVE the drawn in trendline, we could hold on to part of our position. By following this simple rule, we should have stayed in this trade all the way up to where the red circle is marked, where we broke below/closed beneath that trendline. Not a bad trade at all!
How to Use Trendline to Decide When to Enter a Trade
The third potential use for trendlines is to help decide when to get into a trade. On this 60 minute USDJPY chart, a supply zone has been defined that we would consider going short against.
As price is moving UP to our supply zone, we are in a short term uptrend. You can use a trendline break to give yourself “permission” to go short. If price would have stayed above the trendline, you would have to patiently wait for a break to hit the short button. If price didn’t break the line before trading all of the way through the supply zone, YOU WOULDN’T HAVE TAKEN THE TRADE, which would have prevented a losing trade. Cool trick, huh?
There you have it traders! Three easy ways to use trendlines. For more in depth applications, I’ll see you in class!