Trendline Break Forex Strategy

Introduction

A trendline is a line plotted by the line tool to connect the highest or the lowest prices that are displayed on the chart. In essence, they mark out areas of resistance and support. Just as a break of resistance or support will lead to rapid price decline or advance, so also a break of the trend line will signal movement in price beyond the trend line at a very rapid rate. This is why a break of a trendline will invariably lead to a trading opportunity. The essence of this strategy is to add a form of confirmation to the break of a trendline by price action.

Trendlines can equally be drawn in a trend to connect the price lows or the price highs. In a trend however, the break of the trend line opposite the trend will be of more importance to us who are practitioners of this strategy. So in an uptrend, we will be interested in price breaking below the lower trend line. We will also be interested in price breaking above the upper trend line in a downtrend. We will use the change in colour of our MACD histogram to support the price move in the opposite direction. In other words, the trendline break strategy will be a trend reversal strategy.  So in essence, this is a trend reversal strategy.

Indicators

We shall use only one indicator for this strategy, and that is the coloured MACD histogram. Though not an indicator, we shall also be using the line tool to draw our trend lines. For our analysis, we will use the four-hour and daily charts. These charts are better indicators of the trend of an asset. Short term charts do not do the job here.

The Strategy

The strategy is simple and can be used for long and short trades. Usually in an uptrend, retreating prices will bounce off the lower trend line and move back up. This creates specific price lows which can be connected with a trend line. It is the downside break of this trend line that we will be looking to trade as a short trade.

The same thing goes for price action in a downtrend. Attempts by price to pull up are usually rebuffed at the upper trend line, creating price highs which can be connected with a trend line. It is when prices move up and are able to break this trend line that we can consider a long trade. Please note that for a trend line to be valid, it must touch at least three of such defined price highs or lows, depending on what the trend is.

We therefore discuss each individual trade as follows:
1) Long Trade

For the long trade, we want the price action to break above a trend line which connects the highs of candlesticks making up the price action.

  1. Look out for a downtrend on the 4hour or daily chart.
  2. See if you can use the line tool to connect at least three different candle highs to form an upper trend line.
  3. Look out for a candle which closes above this trend line. This is the breakout.
  4. Check to see if the MACD histogram is blue.

Once these four parameters are confirmed, open the trade when the next candle pulls back a little to the broken trend line. A Limit Buy order will also work very well here. We see an example of this in the setup below:

MACD_trendlong

Trendline Break Strategy for Long Trade in Action

We see clearly from this snapshot that the price action broke through the trend line and pulled back a little. This is the BUY area. The snapshot was taken from a 4hour chart of the EURUSD.

Short Trade

For the short trade, we want the price action to break below a trend line which connects the lows of candlesticks making up the price action in an uptrend.

  1. Look out for an upward trend on the 4hour or daily chart.
  2. See if you can use the line tool to connect at least three different candle lows to form a lower trend line.
  3. Look out for a candle which closes below this trend line. This is the breakout.
  4. Check to see if the MACD histogram is red.

Once these four parameters are confirmed, open the trade when the next candle pulls back a little to the broken trend line. A Limit Sell order will also work very well here. We see an example of this in the setup below:

MACD_trendshort

Trend Line Break Short Trade in Action

Stop Loss

The trend line provides the benchmark for the stop loss. Once price action has broken the trend line, it is not likely to go to the other side of the trend line. So set your stop loss on the side of the trend line opposite where the breakout has occurred.

Take Profit

The trader can set the take profit area using discretionary means, but sticking to technically sound parameters for achieving this. This could be double or triple the stop loss setting, or using a trailing stop when a certain number of pips has been attained.

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