This week’s question comes from Thony, who asks:
What is the best way to place the most accurate trend line?
Trend lines are one of my favorite ways to determine the strength of a trend. The way a market tests these levels and even how often can indicate whether momentum is strengthening or waning.
But trend lines are only useful if placed correctly. Otherwise, you could find yourself missing opportunities or worse, getting caught on the wrong side of a market.
With that said, drawing diagonal levels isn’t an exact science. There are usually multiple ways to interpret the proper placement, which is what makes trading such a subjective business.
So while I can’t show you the only way to do it, I can give you a few pointers that have helped me over the years.
In this post, we’ll cover which currency pairs tend to respect trend lines the best. We’ll also examine whether it’s better to use the extreme highs and lows of a candle or the body when drawing these levels.
Let’s get started.
Currency pairs like the EURUSD, GBPUSD, AUDUSD, etc. tend to respect trend lines better than others. This is partially due to the increased volume in these pairs versus other less liquid ones.
However, that doesn’t mean you can’t use trend lines on a currency cross like EURGBP or EURAUD. In fact, I’ve had some extremely profitable trades using nothing but trend lines on crosses such as these.
But if you’re just starting out with diagonal levels, you may want to stick with the majors.
Now, although USDCHF and USDCAD are considered major currency pairs, I’d be careful with these two. The Canadian dollar pairs can be difficult to read at times, and the same goes for the Swiss franc.
Nevertheless, the list above is a good place to start.
The Japanese yen crosses are another basket of currency pairs that I favor when drawing trend lines. In fact, from a technical standpoint, pairings like the AUDJPY or NZDJPY can sometimes produce exceptionally profitable patterns.
At the end of the day, it comes down to liquidity. The pairs with the most volume tend to move in a way that’s more conducive to using trend lines.
The most common mistake I see when a trader plots a trend line is cutting off the wicks of candles. Those highs and lows are there for a good reason and should be respected.
Now, there are cases where it makes sense to cut off a wick or two. Trading with price action like any other style is never a perfect science. Rather it’s a blend of art and science.
My rule of thumb is to use the most conservative placement. That means using the extreme highs or lows of the wicks whenever possible.
By doing this, you reduce the chance of being caught off guard by a false break. Said differently, you’ll be more confident that any resulting break is a potential change in direction.
Here’s an example of one such trend line on the EURAUD daily chart:
Notice in the example above the trend line cuts through the upper wick. The problem here is that the breakout, which occurred several weeks later, has a big question mark above it. We don’t know whether it’s a valid breakout or not.
Now, if we draw the same level a bit higher to include the high of that first candle, we can clearly see the market is still respecting the level as resistance.
By moving the level higher, we would have avoided being caught on the wrong side of the market.
That one little change made all the difference.
There are, of course, exceptions to this rule. Remember that trading is never a perfect science.
A recent trade of mine on the EURCAD comes to mind. Notice that the level below cuts off several lower wicks on the 1-hour time frame.
I ended up shorting the break of support. I also mentioned this trade idea in the Daily Setups section of the website.
How could I have had such a high degree of conviction in a level that was cutting off so many lows?
To find the answer, we have to go back to a Q&A post I wrote a while back. In it, I discuss why a trader might be inclined to use a channel instead of a simple trend line.
The EURCAD chart above is an excellent candidate for using a channel instead of one diagonal level.
Let me explain by showing you what happens when we use the two upper wicks as our starting point for an ascending channel.
Notice how the lower level runs parallel to the upper one that connects the two highs. This gives us a channel from which we can construct an idea to go short once support gives way.
Once I noticed this pattern and observed how the pair was holding above channel support on a 1-hour closing basis (before breaking down), I had enough information to make a decision.
You could have drawn a trend line in place of channel support using the bottom of the wicks, and that would also be acceptable. However, you wouldn’t have had a chance to enter on a retest of the level as new resistance.
This particular setup was also extremely asymmetric and positively skewed at more than 5R, or 10% profit if risking 2% of your account balance. Factors like this helped persuade me to take the trade.
The main takeaway here is that the upper level of the channel gave me confidence that the lower level was positioned correctly. Also, the way the pair held above it on a 1-hour closing basis on several occasions only helped boost my confidence in this pattern and the subsequent break.
Without drawing a channel, I probably would have never found the break that led to a profit of more than 200 pips.
Being successful with price action is 90% observing and 10% doing. Even that’s probably giving too much credit to the action side of the equation.
Whenever I write a new lesson on a trading strategy or technique, it’s invariably followed by emails from traders asking what indicator I use to identify setups.
As you may well know, I only use the 10 and 20 exponential moving averages. And unlike most, I don’t use them as a crossover where one side is bullish and the other bearish.
Instead, I use them to find the mean on the daily or weekly time frames. That’s it.
I found many years ago that indicators did nothing but clutter my charts. Everything I need to know is already there and can be extracted via the price action that occurs daily.
But just as important is the idea of screen time. You see, the more time you spend staring at indicators, the less time you have to study your charts.
You may think those are one in the same, but they aren’t. Take it from someone who spent years doing both.
Like anything, becoming proficient at drawing trend lines takes practice. It takes an obscene amount of screen time which means nothing but you and the price action in front of you.
The more indicators you have on your charts, the longer it’s going to take you to get good at identifying trends and drawing levels.
Those indicators you love to use demand your time and attention which detract from the time you could be using to study price action.
There is without question a certain gut feel that all traders who put in the time eventually develop. It’s what I refer to as the X-factor that can only be attained through years of hard work and perseverance.
It’s the one thing I can’t teach.
But with every level you plot on your charts, you take one step closer to having that X-factor and achieving consistent profits in the Forex market.
Trend lines are an excellent way to identify areas of value within a given trend. They can be used to find setups with the momentum and even signal a change in trend under the right circumstances.
However, be sure to choose your currency pairs wisely. Those with the most liquidity tend to outperform others when it comes to drawing trend lines.
When trying to identify the best placement, always go with the most conservative. It will help with your entries and will offer a better perspective of a potential breakdown in the trend.
The only exception to this rule is if an ascending or descending channel exists.
When in doubt, see if using a channel helps. Sometimes having two or more wicks as a starting point can help you understand what’s happening between buyers and sellers.
Like everything, it takes a ton of practice to get trend lines right. So be sure to keep your charts free of clutter so you can focus on the price action in front of you.
I’d love for this new weekly Q&A to be successful and provide an invaluable repository of answers to common Forex questions.
To do that, I need your help.
Here’s what you can do to get involved and have your question answered in next week’s post: