Support and resistance, trends, trendlines, price swings, these are the basic tools of the Forex trader. We always want to trade with the trend, going against the trend is like trying to swim up-current. It’s much easier to go with the flow.
Trends and Trendlines
Trendlines are an important tool in your toolbox as a Forex analyst and trader because they project price levels where the market is likely to bounce.
If you can draw trendlines correctly you will be able to define buy and sell zones and maximize your trading potential.
Both uptrends and downtrends can be defined by three primary trendlines: the inner trendline, the outer trendline, and the outer long-term trendline.
Finding Your Inner, Outer, and Long-term Outer Trendlines in an Uptrend
An uptrend is a series of price swings where the market is making higher highs and higher lows. Just as there are trends inside of trends, there are price swings inside of swings.
An uptrend price swing starts at a low and ends at a high.
Price Swing in an Uptrend
In an uptrend, the market is making higher highs and higher lows (as prices increase overall).To draw a trendline when the market is in an uptrend, draw a line across the lows.
Remember: “The Trend is Your Friend Until it Bends.”
In any trend, there are three main trendlines: the inner line, the outer line, and the long term outer line.
To draw a trendline in an uptrend, draw across all levels of support.
If you have identified that the market is in an uptrend (the market is making higher highs and higher lows), you should draw all three of your trendlines before making a trade.
To draw the inner upward trendline, locate the last two levels of support (beginning from the current market price at the right of the chart) and draw your trendline between those two levels, extending it forward and up to the right.
Next, draw your outer upward trendline. First locate all your levels of support. Then, starting from the left side of the chart, draw your trendline between all the levels of support, extending the line forward and up to the right.
You will find that if when the market breaks the inner trendline, prices generally move to the outer trendline.
Drawing the Third Trendline
To find the third trendline, the long-term outer trendline, you will need to switch your chart to show a longer timeframe. For example, if you locate your inner and outer trendlines on a 60-minute chart, switch to a daily chart to locate your long-term outer trendline.
Once you are looking at a longer time frame, drawing your outer long-term trendline is the same as drawing the outer trendline: after locating all your levels of support, start from the left side of the chart and draw your trendline between all those levels, extending the line forward and up to the right.
Just as the market will likely move to the outer trendline if the inner trendline is broken, so will the market likely move to the long-term outer trendline if the outer trendline is broken.
The principle behind the three types of trendlines is this: there are trends inside of trends. The market moves in swings, which viewed over a long period of time are long and slow moving. But there are other swings that exist inside of those market swings, and they can be found within shorter time periods. For example, you will be able to identify price swings (trends) looking at a daily chart that are not very volatile (the swings are, once again, long and slow moving).
Looking at the same currency cross on a 60-minute chart you will see trends that are more volatile (the swings are shorter and move more quickly). The smaller your time frame, the more swings you will see.
Three trendlines help you see important support levels
Trading Trendlines in an Uptrend
To trade the inner upward trendline, buy when the market hits the inner upward trendline. Set your protective stop loss order (as always) at the last level of support. To trade the outer or long-term outer trendlines, buy when the market hits the outer upward (or outer long-term upward) trendline, setting a protective stop loss order at the last level of support.
You will sometimes see the inner and outer trendlines converging. This convergence is like a double or extra-strong signal, offering you two hints that the market will bounce. In this case, buy when the market hits the inner and/or outer trendline setting your protective stop loss order at the last level of support.
Now you’ve been introduced to uptrends. In my next post, I’ll show you examples of downtrends.