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Using a Valid Trendline

By Richard Krivo, Trading Instructor
31 October 2011 21:35 GMT

When executing trades based on a trendline, it is important that the trendline is a valid one. This validation would occur when price has touched and respected the trendline a minimum of three times.

Take a look at the current 4 hour chart of the AUDCAD below for an example…

Using_a_Valid_Trendline_body_3rd_touch.png, Using a Valid Trendline

The first point on any chart is simply a random point on that chart. When a second point appears, no matter where it appears on the chart, it can be connected to the first by a straight line but that really tells us nothing. When the third point occurs and it can be connected by the same straight line that connects points 1 and 2, now we have something from which we can trade.

Once the third touch occurs, provided that the candle does not close above the trendline in a downtrend or below the trendline in an uptrend (in other words price respects the trendline), we would take a position at the open of the next candle. Our stop would go below the trendline in an uptrend or above the trendline in a downtrend.

Looking at the above chart, a trader could take a buy (long) position at the open of Entry Candle A with a stop (red line) just below the trendline. A trader could also take a buy position at the open of Entry Candle B with a stop just below the trendline. Going forward, if the current open candle, the last one on the right of the chart, closes above the trendline, a trader could take a long position at the open of the next candle (not yet on the chart) with a stop just below the trendline.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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31 October 2011 21:35 GMT