The beginning of a new trend is often where the largest moves happen because at this point the new market sentiment has to be strong enough to overcome the previous trend. But because there will still be a large number of traders who believe in the previous trend, the beginning of a new trend is often volatile leading to the trader being stopped out prior to the price moving in the predicted direction.
That means we as traders have to select good entry points when we believe the previous trend is over and a new trend is beginning.
So taking things from the beginning, how do we visually define a trend on a chart? The answer is The Trendline. In simple terms, a trendline joins together higher lows (in the case of an uptrend) or lower highs (for a downtrend), like so:
A trendline in effect is a sloping support or resistance line. With a regular horizontal support level, once it has been broken, it can turn be tested from the other side as resistance, like on this 1-hour EURUSD chart:
This works the other way around, i.e. a previous resistance turns into support. The price does not always have to return to a level to retest it from the other side, but it is very common to see it happen.
And in the same way support can turn into resistance on a horizontal level, the same thing can happen with a trendline. Using this knowledge, we can plan trades once a trendline has been broken.
Horizontal support & resistance lines are very easily to spot on a chart and they are seen and used by a lot of traders. However, sloping trendlines aren’t always seen easily and they are often overlooked, especially when they’re broken and retested. Yet, this is when trendlines produce the best and safest trades.
Let’s look at a real trade example on the 1-hour EUR/USD chart:
On this chart, I could see visually that the EURUSD had been trending down (on the hourly chart) and I marked a downward sloping trendline. Notice that when I drew the trendline, it was at the extreme highs of the price-action, and not an approximate line which the price often breached or a line of “best-fit”. Drawing an outer-trendline like this means that when it is eventually broken, it’s significant.
After I marked the downward trendline, the price jumped past it and broke it decisively. Now at this stage, it could be a false breakout and the price could still be trending down. This is why it’s not safe to enter a buy order on the first breakout.
The price then retraced back down to test the trendline. A decisive candle formed that touched the line precisely before closing at the high of the candle. (That particular candle is called a hammer because of its shape.)
Once that candle closed (marked by the third arrow), the price in my mind had made its final retrace before wanting to push up into a new trend. I placed a buy order, with my stop-loss just below the trendline (22 pip stop-loss). I got out at 45 pips, aiming for a 1:2 risk/reward ratio. The price did continue to move up over 70 pips before pulling back, but I was satisfied with a full 1:2 trade.
Because the candle that retested the trendline touched and bounced off it so precisely, I did not in this case zoom into a lower timeframe such as the 5-minute chart to pin my entry. I was happy entering the trade based purely on the 1-hour chart.
This is a particularly clean example and of course not all examples are like this. In the coming weeks, we will look at some more examples that may not be quite so visually clean, but still produce excellent trades.
In summary:
1. Accurate trendlines mark the direction the price is travelling in.
2. Trendlines act as support and resistance just like horizontal levels.
3. Once a trendline has been broken, its retest can be traded in the same way when a horizontal level is retested.
