Our series on TREND LINES in the Forex market continues with part 2. Today we focus on explaining the psychology behind trend lines, what information the trend line angles provide, how trend lines build chart patterns, and how to use trend lines for breaks and bounces.
If you are interested in reviewing part 1 of the “Number 1 Handbook on Trend Lines” again, you can do so by clicking here.
THE PSYCHOLOGY BEHIND TREND LINES
The speed and ‘psychology’ of the market can be measured by the angle of trend lines. Or in other words, traders can use trend lines to measure if there is momentum in the market – and if so, how much momentum. Basically, the angle reveals not only the direction of the market (slope is trend direction) but also its pace and speed.
That information is important for Forex traders because it helps distinguish a swing high and swing low (read more here) from being either corrective or impulsive. And knowing this then helps traders with trading breaks (read here) or trading bounces (read here). Let me explain further.
Trend lines can be roughly categorized in steep, moderate, shallow, and flat trend lines. It is not needed to have an exact measurement of the angle; a rough idea what the angle could be is enough. However, here are more precise guidelines:
- SHALLOW trend line has a sloop of 0-15 degrees OR 2 to 4 o’clock angle
- MODERATE trend line has a sloop of 15-40 degrees OR 4 to 5 o’clock & 1 to 2 o’clock angle
- STEEP trend line has a sloop of 40 degrees + OR 5 to 6 o’clock & 12 to 1 o’clock angle
- FLAT trend has no angle
Today’s post focuses on shallow trend lines, whereas part 3 will discuss moderate and steep trend lines.
SHALLOW TREND LINES AND HOW TO TRADE THEM
A shallow trend line means that the market is in a corrective phase. Contrary to impulsive price action, the corrections are more complex and can become more complicated. The corrective phases when price just chops around or floats sideways lasts a great deal longer than impulses- roughly 3 to 4 times as long.
1. Price is not breaking the tops and bottoms, which is a chart pattern called a contracting triangle or wedge. When placing a trend line on tops and bottoms, the two trend lines have the opposite direction but have roughly the same shallow angle.
2. Price is breaking the top OR bottom to one direction, which is a chart pattern called a bear or bull flag. When placing a trend line on tops and bottoms, the two trend lines have the same direction and roughly the same shallow angle (but it is ok if the angle of the top and bottom line differ from each other).
3. Price is breaking both the top AND bottom, which is a chart pattern called the expanding wedge – although quite rare compared to the patterns in point 1 and 2. When placing a trend line on tops and bottoms, the two trend lines have the opposite direction and the angle could vary in its angle (but it is ok if the angle of the top and bottom line differ from each other).
Forex traders have various ways on how they could trade the corrective price action:
1. BOUNCE TRADER: Forex traders can take bounce trade setups off of the trend lines within the corrective price movements. This means that Forex traders are anticipating price to use or respect the support or resistance line and not break through it. As long as the correction lasts, this trade plan would work out until the moment the chart pattern fails and price breaks the pattern by going through the bottom or top trend line (the last trade is often a loss). The target is either the middle of the chart pattern (conservative target) or most often the opposite side of the chart pattern. Be cautious of the fact that corrective patterns with shallow trend lines often have small space between the top and bottom lines, which means profit potential could be (too much) limited.
2. BOUNCE TRADER FOR BREAOUT: Forex traders can take bounce trade setups off of the trend lines within the corrective price movements BUT with a different target in mind. They are targeting a price which is either below above the chart pattern because they are anticipating the break of the chart pattern. In most cases it is better to position oneself with the previous momentum or trend direction; because the chances are higher that price will break to the same direction. So in a downtrend, its best to pick the tops within the chart pattern for a downside break out. In an uptrend, its best to pick the bottoms within the chart pattern for an upside break out.
3. BREAKOUT TRADER: Lastly, Forex traders can choose to wait for the corrective chart pattern to break and only trade when a new impulse is starting. When chart patterns break there is a higher chance that an impulse will occur, but never a guarantee. Occasionally corrective charts break and price does not become impulse but in fact expands the size of the corrective pattern or reverses (false break outs). In other cases quick momentum can occur when a pattern breaks and price can move up and/or down a lot, which is exactly what the breakout trader is looking for. There are various ways of trading the breakout. A trader does not have to trade a break of the chart pattern immediately, but could opt for more confirmation by letting price pullback to pattern, letting price pullback to pattern and bounce, and taking a 2nd breakout.
EXERCISE: practice the above by drawing 2 trend lines on a corrective piece of price action. Post the chart down below and explain what chart pattern is visible.
NEXT WEEK’S GOAL
Next week’s article (part 3) will review both steep and moderate trend lines and how trade them. We will also explain how trend lines and trend channels interact, why using the two concepts in tandem is such a powerful trading strategy, and problems which occur with trend line trading.
Don’t forget to post the exercises down below. Thanks for sharing this article and wish you Happy trading and a nice weekend.
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