Support and resistance levels are considered one of the most used technical tools in the Forex market. These charting points can be used to find out which direction to trade, time entries, as well as to establish position exits. More often than not these convenient levels are found through drawing lines inside of our graphing software, so today we are going to focus on drawing trendlines on the chart.
When you begin drawing trendlines it is important to remember that not every trader will draw their line the same. Where you draw your lines may not be exactly where I place mine. This is ok as long as we remember the key rule that trendlines must connect at least two common points on our chart. Let’s take a look at a few examples.
(Created using FXCM’s Marketscope 2.0 charts)
Above we can see our first example using a weekly chart of the NAS100 (Nasdaq). The NAS 100 is considered in an uptrend as it has moved 1832 points higher over the course of the last 42 months. Our first trend line is drawn by connecting a series of ascending low points on our graph, which are circled in green. This line is acting as support since price is expected to act as a floor in this scenario, with price holding at these levels.
Once this trendline is drawn, traders will look to take advantage of new higher highs by creating buy orders. The optimal time to take new long positions in an uptrend occurs when price trades down to support and bounces. Once prices has touched support but not closed below it, traders may look to establish new buy entries. When trading an uptrend, traders can also limit risk by establishing stop losses underneath support.
(Created using FXCM’s Marketscope 2.0 charts)
In our next example above we can see an 8Hour chart of the EURAUD declining in a downtrend. Notice how the resistance trendline is formed by connecting the highs on our graph marked in green. On this chart, prices have recently touched the resistance line for the 4th time. It is important to note that the more times a trendline is tested without breaking, the weaker it becomes. Due to this, trend traders normally prefer to trade trendlines on either the third or fourth test.
Since our trendline is pointed down and price is moving lower, we should consider the EURAUD in a strong downtrend. Trend traders can use this information to trade market swings by looking to sell new positions when price moves back up to resistance. Traders should look for prices to touch resistance but not close above it. When price begins moving back in the direction of the trend, we have a valid sell signal. In this scenario stop losses may be placed above support.
---Written by Walker England, Trading Instructor
To contact Walker, email wengland@fxcm.com. Follow me on Twitter at @WEnglandFX.
To be added to Walker’s e-mail distribution list, send an email with the subject line “Distribution List” to wengland@fxcm.com.
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