Mark Thomas — Trade On Track
While on the topic of fractals, here’s another great use for them: drawing trend lines! Trend lines are a very important part of technical analysis, in fact, they’re probably the one thing you need to get right before you move onto more advanced forms of technical analysis. Trend lines can be drawn in lots of different ways, but I’ll explain in this article and video how to draw basic uptrend and downtrend lines using fractal points. Trend lines are great for identifying breakouts and therefore, possible trade entry points.
Trend lines basically identify areas of support and resistance. A downtrend line (a line that is moving down from left to right) can be interpreted as a resistance line (price finds it difficult to move up and through it), and an uptrend line can be interpreted as a support line (price finds it difficult to move down and through it). Trend lines can be drawn on any time frame, but they tend to be “stronger” on the higher time frames.
Just to recap: we define an upper (or bearish) fractal as a high with two lower highs on either side of it. Similarly, we define a lower (or bullish) fractal as a low with two higher lows on either side of it. Fractals are often called pivot points or swing points.
When drawing trend lines, I start on the right-hand side of the chart and draw back to the left. It’s nice to have the lines automatically extended off to the right of your chart, so it depends what charting program or trading platform you use. With Oanda’s charts, it’s easy to draw from right to left, and the lines are extended automatically to the right. With Metatrader, you have to draw from left to right in order to have the lines extend to the right.
To draw a down trend (or upper trend) line, find the last high (or bearish) fractal on the right-hand side of the chart. Then, look to the left and identify the next fractal point that is higher than the one on the right. Draw a line between the two highs.
To draw an up trend (or lower trend) line, find the last low (or bullish) fractal on the right-hand side of the chart. Look left and identify the next fractal point that is lower than the one on the right. Draw a line between those lows.
As more candles or bars are formed on your chart, new high and low fractal points will be established. As each new fractal point is formed, re-draw your trend lines.
Breakouts can often be identified when price breaks through the upper or lower trend line. On a 15 minute chart, I generally like to see a candle CLOSE at least 5 or 6 pips above or below a trend line before I consider it to be a breakout. Quite often you see a candle punch through a trend line, but retraces and still closes within the boundaries of the line – so it can’t really be considered a breakout.
If you are considering entering a trade based on a breakout of a trend line, it’s much safer to wait for price to break through, move in the direction of your intended trade, then pull back to within a few pips of the original trend line (which might be several candles after the break). If you wait for the pull back, it’s usually a safer way to get into the trade, avoiding false breakouts.
Finally, you can use a trend line to trail a stop too. If you’ve bought on a break out of the upper trend line, you can place your stop just below the lower trend line and follow it up as price moves up. It’s a good idea to leave 7 or 8 pips between the trend line and your stop loss on a 15 minute chart. This buffer can be extended up to 15 or 16 pips if you’re trading higher time frames, like daily charts.
The short video below shows how to draw trend lines and how you could have profited by selling the EUR/USD after a double-top on the hourly, earlier today:
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