Trend line trading is one of the most common ways to get started with price action strategies. Due to the simplicity of trend lines, this is often the starting point for beginners in forex and crypto trading.
By learning to draw trend lines and price channels, you can obtain early signals for trend reversals.
There are two types of trend lines, the bullish or the rising trend line and the bearish or the falling trend line. Trend lines are formed by connecting subsequent lows or highs in the price, which will show you whether the price of the security is in an uptrend or a downtrend.
Trend lines are easy to trade because you can apply them to both forex and crypto markets, as well as any time frame. Thus, a day trader can trade with trend lines on the 5-minute chart, while a swing trader can use the trend lines on the weekly or daily charts.
Once a trend line is drawn, it acts as a dynamic support and resistance level. A trend line doesn't have to be broken all the time, and it works like using the horizontal support and resistance levels.
One of the unique aspects of this trading is that you can draw multiple trend lines. Note that when you start to notice the slope of the trend becoming steeper, you can expect prices to make a correction.
The Rising Trend Line
The rising trend line is formed by connecting the lows of the price. Some traders prefer to use closing prices instead. Whether you use the lows of the price or the closing price is a matter of personal choice.
The USDCAD chart below shows the rising trend line plotted using the higher lows in price. We also plotted an additional trend line with a relatively steeper slope compared to the first trend line.
As you can see, price tends to bounce off the rising trend line, which acts as dynamic support. As a result, price action tends to remain in the bullish trend. However, once a trend line is breached, you can expect to see prices posting a correction.
Most commonly, price tends to revisit the breakout level in the rising trend line before resuming the correction. This pullback can give traders a good price level to go short on the trade. However, this is not always the case.
Depending on the intensity of the breakout, price can continue its correction without a pullback. Traders will need to ascertain this and know how to risk their capital: whether to wait for the pullback or to go short when the rising trend line is breached.
The Falling Trend Line
The falling trend line is formed by connecting the highs in price or the higher closing prices. Again, it is the trader’s discretion on what reference prices he or she wants to use. A breakdown of a falling trend line can signal an upside momentum in price.
This means that when price breaks the falling trend line, you can expect to see a correction in the opposite direction. Therefore, when a falling trend line is breached, it signals a long position.
A falling trend line is equivalent to the horizontal resistance level. The only difference is that the falling trend line is more dynamic. The EURUSD chart below shows how the falling trend line is applied to the charts.
The falling trend line can be traded on a breakout to the upside. This usually signals price action is posting a correction or a reversal of the trend. As with most breakouts, price action can often revert to the breakout level before resuming the correction.
There are instances, as you can see in the above chart, where price does not make a pullback when breaking from the falling trend line. However, with experience, traders will be able to trade the breakouts more efficiently.
One of the greatest challenges when plotting trend lines is the difficulty in gauging the trend line when price is evolving. As price action tends to evolve, traders will find the previously plotted trend lines tend to become invalidated.
Therefore, when using trend lines, you must ensure you are constantly redrawing the trend lines. The ideal trend line has a slope with a 45-degree angle, but as you know of forex and crypto trading, this is not an exact science.
Trading Price Channels
Price channels are an extension of the trend line. In other words, two parallel trend lines form an upper and lower boundary of a channel. Plotting the price channel works the same way as plotting a trend line. However, once the main trend line is plotted, the parallel line is projected to the most apparent low or high.
The concept of price channels is similar to trend lines. A breakout from a falling price channel signals a bullish correction to the bearish trend, and a breakout from the rising price channel signals a bearish correction to the bullish trend.
As you can see in the above chart, after you first draw a falling trend line, the next step is to look at the recent low. Once you identify this, you can simply copy the trend line and connect it to the low point in the trend. Thus, you form the price channel.
In addition to using trend lines, you can use the equidistant tool to plot the price channels automatically on your chart.
Falling Price Channel
The chart below shows the falling price channel. To trade this channel, simply look for the next low on the chart that fails to touch the lower or the outer trend line. This is the first signal that price action is likely to reverse course.
Rising Price Channel
The same pattern seen in the breakout for a falling price channel applies to a rising price channel breakout. Notice the yellow highlighted area on the chart, which fails to touch the opposite line. This gives an early signal that price trend may change.
Trend lines and price channels are two simple ways to trade corrections or breakouts in the trend. Remember, this would ideally be a counter-trend trading. While there are always risks involved, traders can capture profits quickly and efficiently on the forex and crypto markets.