Before trading technologies evolved, before charting software were developed, before advanced algorithms were created to analyse price and take trading decisions, there existed a simple yet very effective tool which generated loads of profit. This tool is called Trend lines. I prefer to call them the oldest known FX secret; they are well publicized and there is a ton of information about how to trade using trend lines, yet every few traders realize the impact this tool can have one a trading career. The beauty of trend lines is that they can be applied on any chart and on any time frame.
The forex or currency markets are mainly governed by demand and supply. When the demand for a currency is high, the currency appreciates. A vibrant and robust economy usually gives rise to a strong currency. In the same vein, an economy facing economic or financial crisis usually experiences a low demand for its currency. The principal task of every trader is to determine which currency or currencies is/are in demand, and exploit that information for financial gain (Almost sounds like insider trading).
Demand and supply are very visible on the charts. Resistance and support levels are the best indicators to gauge the demand for a currency.
A resistance level or area is a region that price has not been able to breach upwards. A resistance level is more respected when price has tried to breach it several times and failed. Below is an example of a resistance area on the one-hour chart of the EUR/USD.
We can see the reaction of price to the breach of the resistance level. How is this information relevant? Once we can identify a resistance level or area, the probability of price climbing upwards after a breach is very high. A breach upwards simply shows that there is more demand than supply for the gaining currency.
Likewise,a support area or level is a region that price has not been able to breach downwards. We have no idea where price is going to move next, so all our analysis is done using past data. A support level would reveal an area price has not gone below recently. The chart below shows the USD/CHF pair on the one-hour chart. We can see how price was contained and did not go below a certain level for several hours.
The reaction of price to a breach of support is very similar to a breach of a resistance level. This breach is what is commonly referred to as a break-out. This would mean selling below recent lows (if support is breached) and buying above recent highs (if resistance is breached).
A resistance or support line gives a very good idea of price upper and lower limits, and a breach of these limits can be very rewarding. A trend line on the other hand shows the trend direction. It gives a clear picture of the direction in which the market has been trending.
Below we can see two charts showing an upwardand downward trend lines.
DRAWING TREND LINES
A trend line is a straight line which connects two or more points. To draw a downward trend line, we would need to connect recent high points. The first step would be identifying the high points.
The high points are then connected to give the desired trend line. It should be noted that a downward trend line shows a bearish trend, so a trader would be looking for short opportunities. The trend line acts as a sort of resistance level, every time price refuses to breach it, we can take short positions.
Similarly,an upward trend line shows us a bullish market, so we should look for only long
The upward trend line can be regarded as a support, so trades can be taken as price bounces off the trend line. It should be noted that trend lines are more effective when used to analyze longer time periods. Longer time frames are generally more reliable, because they take into account more data, and the minor fluctuations of price are not as evident as they are in smaller time frames.
There are two basic methods of trading using trend lines. The first to use the trend lines to identify the current trend and take trades as price bounces off the trend line. The second approach to wait for a breach of the trend lines to show a trend reversal, and then take trades in the direction of the new trend. Higher time frames yield more pips.
Upward and downward trend lines can also be combined to form a wedge. When this formation occurs, it is advisable to trade in the direction of the break-out. Either a bounce or a trend line breach can be used to initiate trades, but the most important thing to note is that the trend lines show the trend, and the
trend is our friend only when we take trades in the trend direction.