How to correctly use the Trendline Trading Strategy

Learn how to draw trend lines correctly, with this Trendline Trading Strategy

One of the most basic Forex strategies, called Trendline Trading Strategy is easy to set and identify. Watch our latest video to learn how to do that.

Trendline Trading Strategy – key basic rules

Hello everyone! Today, we are going to go over one of the most basic Forex strategies, called, “Trendline Strategy” and it’s basic, since it has three key rules that are very easy to set and to identify and therefore it offers you a very good risk to reward ratio, which is of course key in every trade. So, we mentioned three basic rules.

So the first would be to identify swing highs or lows depending, is it a bearish or a bullish trendline strategy? We have two examples here, in two major pairs, Euro/Dollar and Dollar/Yen to show, and to show how this strategy actually works in practice. So here, we have the Euro/Dollar. Here we are clearly in a downtrend because we are creating lower highs and lower lows and therefore, we are trying to identify peaks. So, here would be the first, and then, as the price goes down, then we are looking for a second peak that we can connect with the trendline, and what’s important here that between these two touches, one and two, we don’t have any break of the trendline. So the trendline needs to have at least two, of course, touches that we can connect and then, as soon as the third happens we are actually looking to enter into the trade. So, the third touch would be the first opportunity to enter into the trade and play the trade against the trendline. So, here we are looking, of course, to sell the pair against the trendline, since it is very easy to identify where your Stop-Loss is and where your Take-Profit is, as we’re going to see, now, in this Euro/Dollar chart example.

So, here we have two touches as we said, and then we are looking for the third touch to enter into the trade. As soon as the third touch happens, here, we can see it happened, in this particular case, at 1.2140. We are selling the price, so we are entering the trade at market at 1.2140, and our Stop-Loss should be approximately, in this strategy, around 10 to 15 pips above the trendline. Here, we are talking about a one-hour chart and this strategy works best on one-hour charts. So, here, we sell the pair at 1.2140, but, actually, why I chose this example, is because here we also have 100 MA, which also provides a very strong resistance to any move that has a tendency to go higher. So, what is actually advisable here is that you use both these lines as resistance, so you will sell at the trendline at 1.2140, but you will put your Stop-Loss, actually, above the 100 MA. Why? Because the price may move briefly above the trendline and then react and turn lower after touching the MA 100. So, here you would put your Stop-Loss approximately 4 or 5 pips above moving average, and you can see here that what happens is the price touched the trendline and then, returned back, of course, rotated back lower. So, after you have identified your Stop-Loss, now you are trying to identify your Take-Profit. Risk:Reward ratio is what you actually see here, so what are you risking in order to gain something? And it should be at least 1.5:1, while, anything up to 2:1 is actually extremely profitable. So, here we are risking more or less, let’s say 25 pips, in order to gain 75 pips. How did we identify this Take-Profit? Well, after we identified our Stop-Losses, actually, we are looking to make some profit in this trade, so we are not looking to risk 25 pips to gain 25, but we are looking to gain, for example, at least 40, 50 pips. And in this particular example, we have a support here, which is a horizontal support. You see that the price touched the trendline here and then rotated back lower and then it bounced from this 1.2060 level, which immediately becomes support. So, for us, we are looking to target that support again, and this is actually what happened in the end. Of course, at this point, we don’t know if this is going to happen, but since we saw that the price has touched this 1.2060, we know that there is going to be some movement and some interest in buying the Euro/Dollar at this particular price. So, the advice would be to take your profit close to this level, not exactly to a pip to this level, but actually 4 or 5 pips. And if you did this, in this particular trade, you would risk, as I said, around 25 pips and you’re gain would be around 75 pips.

Another example that I wanted to show you, is a bit different. It’s Dollar/Yen. Why is different? Because it has many touches. It has many touches and the second rule of this strategy is that the more touches on the trendline, the better. So, it’s much better if you have a trendline that connects four or five touches and if you have a trendline that connects two touches, it gives more validation to this strategy. So, here, you can see we start from here because it’s a low, and it’s the touch number one, and then we have a couple of touches here. Here, you can see four or five touches, where _ to the trendline, but the trendline is still not broken. It’s important to say that we consider that the trendline is broken only when we have a clear close above, or in this particular case, below the trendline. Only in that case, we can see the trendline has been broken. So, here, we see multiple touches, and as I said, as of touch number three, you can actually start thinking about entering into the trade. Intentionally, I put a touch number five here because, as I said, the more touches you have, the better, so if you analyzed this price move, so with four touches, you say, okay, I’m not going to miss another test of this important multi-week trendline and you will enter into the trade here, so you enter, let’s say, around 1.0870, and then, you let, as we said, ideally, since we don’t have anything below the trendline, any kind of support below the trendline, then we are giving around 10 to 15 pips of a caution, in order to defend against this false breakdown that actually happened here. So, this is why this example is extremely valuable to us because it shows us that we broke below the trendline, so the price traded below the trendline, but since we did not close, you see where the close is, we actually created a false breakdown, and then the price rebounded sharply higher. So, here we are buying at 1.0870, we give, as I said, you can give, depending on the risk management, I will advise 10 to 15 pips of Stop-Loss. Here I put 13 pips Stop-Loss, and then your Take-Profit should be the first resistance that you identified in this particular example. We see here two touches at this 1.0893, which was a horizontal support and now is horizontal resistance, so here we are looking to, in this particular example, we are risking 13 pips, in order to gain 22 pips, which is around 1.7:1 or 1.8:1. Of course, we did not know that the price is going to go all over to 200 MA. If you wanted to be more aggressive, of course, you could target this area here. But, as I said, if you want to really keep it simple, just target the first resistance or support that comes next.

So, let’s just do a quick recap. Three quick rules are identified: the swing lows or swing highs, in this example, is swing lows. A second rule is that you need to connect all the swing lows and swing highs and the more touches, the better. So, in this case, it’s the fifth touch that we are trading, and in the Euro/Dollar example, the third touch. And the third rule or step is you need to buy against the trendline if it’s a bullish trendline or you need to sell against the trendline if it’s a bearish trendline. It’s a great strategy since, as I said, it offers a clear area or risk where you’re out with the trade, and you don’t really have to really over analyze chart to see where are you wrong because if the price trades 20, 30 pips below the trendline, then obviously we’re wrong and, again, depends on you how aggressive you are in your trading, but it also can provide you a very good risk and reward. I hope I was very clear. Thank you very much and have a nice day.

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