Trend lines are one of the most important technical ways to analyze a chart. As traders, finding and drawing trend lines correctly is very important. Trends usually act as moving support and resistance levels.
Price often keeps above or below trends, for an extended period of time. Trends are usually good entry points for trade positions. Also, they help us gauge the general direction of the market and how strong the move is.
In this article we will discuss how to profit from trend lines' confluence. This is a complete strategy with entry, stop loss and take profit levels. We will use a simple, step-by-step approach for achieving this goal.
We will analyze the Daily time frame. However, you can use the same technique for any time frame you trade. Some recent charts of EUR/USD are also included, for a better understanding of this method and how easily it can be used.
This is a very technical method. So perhaps it can be automated. If any JForex (or Visual JForex) programmer is interested, please feel free to automate it. I think that many traders, including myself, could benefit from it.
I hope you find this article helpful for your trading. :-)
► What is an Up Trend Line?
Up Trend Line definition:
- A series of higher candles' lows that can be connected with a single line.
- At least three lows can be connected together. In the following example, the three lows are marked with green arrows. The trend line is the green line that connects them:
- Price does not cut through the line, between the three lows connected. The following line looks like an up trend line, as it connects three lows (marked with green arrows):
However, it is NOT an up trend line, as price cuts between the second and third low (marked with a red rectangle):
► What is a Down Trend Line?
Now let's define what is a Down Trend Line:
- A series of lower candles' highs that can be connected with a single line.
- At least three highs can be connected. In the following example, the three highs are marked with red arrows The trend line is the red line that connects them:
- Price does not cut through the line, between the three highs connected. The following line looks like a down trend line, as it connects three highs (marked with red arrows):
However, it is NOT a down trend line, as price cuts between the second and third highs (marked with two red rectangles):
► Price Behavior Around Trend Lines
Let's study how price behaves around trend lines. In the following example, we see a clear up trend line (green line), that connects three lows (green arrows):
At first, price "respects" the trend line. At every test of the trend line, price bounces back up (green arrows). After three tests, price suddenly breaks the trend line and moves beneath it. This is marked with a red rectangle:
After price moves beneath the trend line, we see that this line becomes resistance. At every test of the trend line, price now bounces back down (red arrows):
This is a nice example of "previous support now becomes resistance"!
The important question is: when will the trend line be tested after it breaks down? As traders, we want to predict the test location beforehand, because it offers a very nice trade opportunity. In the example above, if we know that price will test at the red arrows, we will simply sell there with a tight stop-loss just above the trend line (green line).
The truth is that predicting where a single trend line will be tested after it breaks, is quite difficult. However, when two trend lines intersect (=confluence), that area offers a good probability that it will be tested.
The confluence area offers us the following advantages:
- Good probability that it will be tested after a trend line break.
- Predictable and exact entry area.
- Higher success rate. Because two trend lines are being tested, this setup is more reliable than a single trend line test.
► Step 1: Open the Daily Chart
Here is the EUR/USD Daily chart on the Dukascopy Web Platform:
► Step 2: Zoom Out
We are looking for trend lines. So it is important that we see as much price history as possible. We want to see all the existing trends in "the bigger picture" of price movement.
Let's zoom out as much as possible. Just click on the button marked with a magnifying glass and a minus sign (pointed by a red arrow). We will click several times until we see all price history:
► Step 3: Draw All Trend Lines
We draw our trend lines by choosing "Line" from the top menu. Like this:
Then, just point the mouse on the chart where you want to draw the line and left click. If you want to correct the line, you can choose it by clicking on it and dragging it. The line will follow the mouse movements.
Here is the EUR/USD Daily chart with all the trend lines marked. I have manually added green arrows to mark higher lows for an up trend line. I have added red arrows to mark lower highs for a down trend line:
► Step 4: Mark All Confluences
Now, let's mark all the points where two, or more, trend lines intersect. We mark such points with an ellipse. Just choose "Ellipse" from the top menu, like this:
Here is our chart with all confluences marked:
► Step 5: Wait For a Test
Now, we just wait for price to test any confluence point. Here is a zoom-in of our chart example. The confluence point is marked with an orange circle. The Test Candle is marked with a red arrow:
Here are the rules for the Test Candle:
- The candle must be within four candles distance from the confluence point. We find the candle just below the confluence and watch four candles to the left and four candles to the right. Any of these candles can be a Test Candle. In our example, this area lies in-between the dates 10.12-20.12 (marked with two horizontal red arrows):
- The candle's high or low must be no more than 25 pips away from the confluence point. In the following chart, this is the price area between the two vertical red arrows:
- Combining the previous two rules together: let's mark an area, which width is 9 candles (one candle below the confluence point and 4 candles to the left and right) and height is 51 pips (confluence price level + 25 pips higher and lower). This is the orange area in the following chart:
The Test Candle must reach this area and retrace back. The Test Candle doesn't have to touch the confluence itself, but must come really close!
- The candle's close must be at least 15 pips away from the confluence point:
- The candle must be a reverse candle. It must have the opposite color of the previous candle. If the previous candle was red, the Test Candle must be green. And vice verse.
The idea is to see a clear test and bounce off the confluence area. This suggests that price has found strong support or resistance there and started to retrace back.
In our chart, we see two nice examples of this setup. I have marked them with arrows:
Please note that we have found just 4 trend lines and 5 confluence points. Nevertheless, they are all we need to enter good trades!
[Note: the setup with a green arrow couldn't have been traded in reality. The reason is the trend line was established after the confluence point. However, this is a good setup technically, so we will use it for demonstration purposes.]
► Step 6: The Trade
Here are the rules for trading this setup:
- Enter the trade immediately at the close of the candle that tested the confluence (= Test Candle). Here is a zoom-in of our chart, for a better view. We buy at the close of the candle marked with a green arrow. We sell at the close of the candle marked with a red arrow:
- Stop loss is placed around 10 pips above (or below) the confluence point. In the following chart, stop loss levels are marked with red lines:
- Take profit is the next trend line that price touches. For example, The long position takes profit at the green line and filled green arrow:
The short position takes profit at the red line and the red filled arrow:
I would love to hear any questions, comments or suggestions, for example:
- What do you think about this strategy?
- How do you trade Trend Lines' Confluence?
- Do you have any suggestions how to improve this strategy?
Thank you for reading this article. I hope you will find the Trend Lines' Confluence Strategy helpful for your trading. Happy trading everyone! :-)