In last week’s article here we looked at how to construct trendlines and how to use them to find entries on new trends.
This week we’re going to look at another example of a trade I took on the EUR/USD that used a couple of trendlines to find the entry and potential target.
For several weeks from the end of April to the end of May, EUR/USD had been trending down nicely. On an hourly chart, I picked out several points to mark out the trend. (For clarity, I have shown the same trendlines on both a 4-hour chart and 1-hour charts.)
Remember, if you slide your mouse over the charts, you will get an enlarged view. I’d also recommend recreating these trendlines on your own charting platform for the sake of practice.
I could see two key trends: a shallow one marked in red and a steeper one marked in blue.
Now, as expected the price broke the steeper (blue) trendline. Why do I say “as expected”? Because when a trendline is especially steep, the price eventually breaks it to retrace or pullback. Excessive momentum can’t be held indefinitely. My view of the EUR/USD at this stage was this: I was not sure whether the price had bottomed out and was about to move into a new phase upward phase. But I believed that the price once it broke the steep trendline would at the very least move up to the longer-term shallow (red) trendline. The shallow trendline may hold or it may get broken.
Therefore, with the assumption the price would in the near term move up to the red trendline, I wanted to find an entry for a long position. To do this, I zoomed into the 5-minute chart.
On the 5-minute chart, the break of the steep (blue) trendline wasn’t a nice clean break; in fact, it broke it and then ranged about in quite a messy fashion. But eventually, I felt I saw a series of rising supports. I was satisfied that the price was looking to move up to the shallow (red) trendline and I entered after the price had marked another minor low. I kept a 25 pip stop that covered a retrace to the previous few lows.
When the price moved up 55 pips from my entry, I exited the trade simply because I had covered over double my risk at this point. I was happy that I had gotten more than a 1:2 risk/reward ratio on this trade. However, this trade did in fact move up to the shallow trendline as predicted and the entire move was over 90 pips.
Trading trendlines in this manner is one of the most basic concepts in Technical Analysis and has been written about in books for decades. Today, the fundamentals and politics of the Euro are unique to any currency in modern history. However, as the conditions surrounding the markets have changed, these basic trendline concepts still work and work very well. The reason is that whilst circumstances have changed, the core principles of the markets haven’t. The fundaments and news create the sentiment amongst the players in the market, and that sentiment and the attached emotions are translated into price action. That is the basis of why Technical Analysis works today as well as it did over a century ago.
In summary:
1. Very steep trendlines eventually break as excessive momentum can’t continue indefinitely.
2. You can trade the break of a steep trendline if you have enough room against the longer term trend.
3. As with any trade, its success should be measured compared to how much you have risked.
