Trendlines are one of the easiest things to learn in technical analysis. Connect 2 points and you have a trendline. What could be more simple? So what are the trades you can take from a trendline and how are they best used? We’ve all heard “The trend is you friend” and since a trendline defines a “trend” then it seems obvious that you should sell against a downward sloping trendline and buy against an upward sloping trendline. Herein lies the hidden problem, which can be correct by understanding 2 things:
First, without a rule on how to draw trendlines, trading them becomes inconsistent at best, impossible at worst. We once did a trendline experiment, sending a chart out to 5 professional traders that we new and asked them to draw every trendline they saw on the chart. When we got them back and combined them, the chart told an interesting tale.
As with everything, consistency is key. We have our proprietary way of drawing them which makes our trendline trades repeatable, and you have to develop or learn a method that works for you.
Second, the break of a trendline is an easier trade to define than a trade that goes with a trendline. Don’t just look for a test of a trendline that fails, research the breaks. When a market closes beyond a properly drawn trendline, there is often follow through. People often say, “isn’t that counter-trend trading?” The answer is always the same: every multi-candle move is a trend, its just a matter of duration of length of the new trend. So while you may be trading counter to the old trend, you are trading with a new and possibly much shorter trend, as in the Nadex GBP/USD chart below.
Trendline breaks can also give you very clear targets. Looking at the chart, you can see the defining point of our trendline marked by the second red arrow lines up very well with the >1.2280 Nadex binary option, so you may have chosen that as your option to buy after the close above the trendline materialized.
So make sure you draw them in a consistent fashion and use both sides of these simple tools. You may find the trendline is the best friend you can have…after your dog, of course.
We at Path Trading Partners wish you all a happy, healthy and safe New Year!