Now that you have learned the way to create trend lines, it is the time to trade. Hurray!!!
But wait….Before this, you have to learn how to read these trend lines.
You need to learn three important things when trading with trend lines:
- Trending move
- Trend correction
- Break and reverse in a trend (Discussed in Part 4)
So once the line is confirmed, it is the time to make out the area for opening the position. After analyzing the area and confirming if it is a bullish or bearish trend, you can open the position; but make sure that the price action confirms the position. Let’s support this with an example:
Here is the chart of the currency pair AUD/USD. The trend line in this chart is blue which is showing a bearish movement of the price. The top two arrows indicate that the trend line has started building and the third arrow (green) is confirming the trend. After you get a confirmation of the trend, it is the time to enter the market by going short, and that third point should be the entry point.
Just after the entry point, you can see a strong bearish candle that is confirming the entry point. You can call it a perfect signal for entering the market. Now, the trend line is further going down confirming again with a bearish candle. Almost at the end of the line, we can see a new bottom made by the price action breaking the previous bottom.
Further, we go down and see that there is a little bullish candle followed by a strong bullish candle. At this point, the trend line is crossing through the candle indicating the end of the bearish trend and start of bullish one. This is the point where you should close the position.
Many advanced traders spot and trade at price corrections which is highly beneficial, but risky. But before going on to this part of the article we will learn what actually a trend correction is.
If you see the above chart, you will notice that the price is moving down in almost a zig-zag manner. The trend correction brings the price back to the trend line area after an impulsive upward or downward movement. For a beginner, it is difficult to analyze the corrective move as the corrective price may take a time to move back. Also, it should be smaller than the trending move. Trading through corrections is highly profitable, but a lot riskier.
Let us take an example to understand this better. Following is the chart of the currency pair GBP/USD:
In the chart, you can see two blue lines showing a bullish trend. Mostly we create a bullish trend line joining the bottoms, but here we have also created a bullish line joining the tops called parallel trend (will discuss it later). The numbers are just the phases or you can call signals and confirmation of the trend. The green lines are showing an impulsive move and the red line is showing a corrective move.
Now, first of all, let’s come to the parallel trend. In a bullish or bearish trend, the confirmation of an entry point for a currency pair is done at the third point. However, in the case of a bullish trend, you can skip the third point and make the second point as the entry point. But there is a catch here; the second point as the entry point is confirmed only when the other trend line parallel to the bullish trend line is confirming the two points which mean two bottom points and two top points.
According to the chart, if you make only a bullish trend line by connecting the bottoms, you can finalize the entry point as no.6. But while connecting the points 2 and 4 and extend the line to create a trend, you have also connected the points 1 and 3 and extend it out which is a confirmation that there is a bullish trend. This is called a parallel trend. Now according to the parallel trend, you can open the position at point 4, and the position can be confirmed at point 5. Many traders are not aware of this profitable strategy.
And many take a risk and trade by selling at the tops with a target near the bottom. This is called a countertrend trader.