Yesterday I showed you how you can find buy and sell zones when the uptrend break. Today, you will learn how to apply this strategy to a breaking downtrend.
Before you can start trading currencies, you need to know when the downtrend breaks.
The Broken Downtrend
A downtrend is considered broken if the following conditions are met:
- The market makes a new low.
- The market first penetrates the trendline.
- The market then retraces to the last level of resistance.
When the downtrend is broken, the market enters the buy zone, which is the area above the trendline.
Remember, the trendline is only considered broken if all three of the conditions are met. That is, the market must have made a new low prior to piercing the trendline or it is not considered a trendline break.
Trading the Buy Zone
Trading currencies in the buy zone is one way to take advantage of a downtrend break. To trade currencies in the Forex online when prices enter the buy zone, wait until a complete bullish candle forms above the trendline (it must completely clear the trendline, wick and body).
Take care to wait until the candle has closed to call a trendline break; otherwise you may fall victim to a false spike. When the bullish candle appears in the buy zone according to the conditions stated above, place a market order to buy at the opening of the next candle (if equity management allows).
Set your stop loss order at the last level of support like in this Forex chart shot:
Rules For Trading Currencies In The Buy and Sell Zones
As with every indicator, there are several important rules to follow when trading currencies in the buy and sell zones:
- Draw all trendlines (inner, outer, and long-term outer) – This will help you determine if the market is trending up or down, or if a trendline has been broken.
- Locate the downtrend (uptrend) break and the bullish (bearish) candle in the buy (sell) zone that confirms the break.
- Find the last level of support or resistance to determine where to place your stop loss order.
- Manage your equity – If you can’t afford the potential loss (the loss you would incur should the market reach your stop loss order), don’t make the trade.
- Create a plan for trading currencies – Trade the plan.
In addition to those important rules, it is also important to decide before every trade whether you will be a day trader or an overnight trader.
A day trader will stay in the market (on that trade) for a short amount of time (a couple of pips, perhaps) whereas an overnight currency trader will remain in the market for three or four days, canceling and replacing to lock in profits.
Remember that when the inner trendline is broken the market predominately (most often) moves to the outer trendline and bounces there. One way to estimate the potential profit to be made if you are trading an inner trendline break is to calculate the difference between the inner and the outer trendlines. If there is not much price difference between the two lines, you will likely not make much profit trading the inner trendline break.
When both the inner and the outer trendlines are broken, that is a sign of a major reversal. That the inner and the outer trendlines broke indicates that the market is not in a price swing within a larger continuing trend, but that the larger trend itself is breaking.
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