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One of the most efficient tools to follow
a trend are trend lines.
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Trend lines are lines that connect consecutive
higher lows in an uptrend and consecutive
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lower highs in a downtrend.
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A trend line is most helpful when looking
for entries in the direction of the trend
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on pullbacks and in the opposite direction
after the trend line is broken.
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While they’re relatively easy to apply on
a chart, there are some trend line misconceptions
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and mistakes made by traders in their analysis.
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That’s why in today’s video I will share
10 important trendline rules that all trend-followers
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need to know about.
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1.
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Ignore the candle wicks
Trend lines are only useful if placed correctly.
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Otherwise, you could find yourself missing
opportunities or worse, trading on the wrong
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side of a market.
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With that said, drawing diagonal levels isn’t
an exact science.
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There are usually multiple ways to draw a
trendline but from my experience, the best
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trend line is applied by using the candle
bodies and ignoring the tails, and let me
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explain why I prefer this method.
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The wicks on a candle show how far price went
in one direction before market participants
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decided to the reverse direction.
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In my opinion closes are more important and
they carry more meaning.
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If a candle closed at a certain level, that
means that market participants were ready
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to accept this level as a market balance point.
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Highs/lows on a candle are the maximum/minimum
they were willing to pay over a certain time
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period.
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Thus, closes are the places where the majority
of traders agree on a certain price level,
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which makes the level more significant.
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I recommend using a line graph to plot major
trends and support and resistance as it focuses
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on the close price.
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Draw a few trendlines on a line chart, then
change to candlestick view and see how irrelevant
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the tails can be.
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2.
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Treat trend lines as areas
Price is a very dynamic concept, and volatility
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and momentum can affect price moves in significant
ways.
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This is especially true when we look at trendlines.
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When traders are trying to place a trade at
a very obvious price level, the professional
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traders know this ,and they will do their
best to kick out the amateurs by letting price
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spike through levels or make it turn before
the actual level.
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To overcome this shortcoming and to improve
your trading skills, you need to start using
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areas instead of just single trendlines.
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By using areas, you can create “noise zones”
and filter out a lot of market noise.
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If you use trendlines as zones, then you don't
need to worry about drawing trendlines along
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the exact highs or lows.
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You draw "trendlines of best fit."
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3.
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The more connecting points, the better
As a general rule of thumb, the more times
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a trendline has been hit and respected with
a bounce, the more important the level is.
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To truly validate a trendline, you need to
see the price react from a line projected
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from a trendline drawn based off of two prior
points.
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Essentially, a third high/low is needed to
truly solidify a trendline.
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Once you have this, you can then feel better
about looking for opportunities to exploit
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the market when price reaches the trendline
again.
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4.
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Spacing between connecting points matters
The lows used to form an uptrend line and
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the highs used to form a downtrend line should
not be too far apart, or too close together.
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The most suitable distance apart will depend
on the timeframe, the degree of price movement,
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and personal preferences.
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If the lows (highs) are too close together,
the validity of the reaction low (high) may
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be in question.
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If the lows are too far apart, the relationship
between the two points could be suspect.
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An ideal trend line is made up of relatively
evenly spaced lows (or highs).
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So, why it’s important to measure the time
between consecutive touches?
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Well, before a breakout occurs, the price
tends to cluster around the trendline and
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the time between the consecutive touches tends
to become shorter.
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As you can see on this example, we draw a
trendline that connected several higher lows.
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As the uptrend started to lose momentum, the
times between each consecutive touch on the
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trendline became shorter.
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Finally, the time between the last two touches
was very short, after which the price broke
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below the trendline and started a strong downtrend.
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Buyers weren’t strong enough to defend the
trendline as sellers kept pushing the price
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lower.
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So if the market repeatedly tests a trend
line many times in a relatively short period
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and the price cannot drift far from that trend
line, then a breakout will likely happen.
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Most of the time, the market will break through
the trend line and attempt to reverse the
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trend.
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Of course, this is not always accurate, but
when I see this pattern, I’m inclined to
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trade a breakout, rather than a continuation
play.
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5.
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The angle of the trendline matters
As the steepness of a trend line increases,
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the validity of the support or resistance
level decreases.
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A steep trend line results from a sharp advance
(or decline) over a brief period of time.
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The angle of a trend line created from such
sharp moves is unlikely to offer a meaningful
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support or resistance level.
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Even if the trend line is formed with many
valid points, attempting to play a trend line
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break will often prove difficult.
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6.
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The most profitable trades are in the direction
of the trend line
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Once a trend has been established by a series
of trending highs and lows, the most profitable
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trades are in the direction of the trend line
until the trend line is broken.
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Every time the market pulls back to the area
around the trend line, even if it undershoots
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or overshoots the trend line, look for a reversal
from the trend line and try to enter in the
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direction of the trend.
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One of the most important points that everyone
needs to accept as reality is that most breakouts
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fail!
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The market repeatedly races toward a trend
line with very strong momentum, and it is
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easy to get caught up in the strength of the
bar and overlook the big picture.
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For example, when the market is trending up,
it has many strong sell-offs that quickly
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drop to the bull trend line.
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This makes beginners assume that the market
has reversed and they sell just above, at,
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or below the trend line.
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While beginners are shorting near the bull
trend line, experienced traders are doing
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the opposite.
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They have limit orders to buy at and just
below the trend line, or they will buy there
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with market orders.
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The market usually has to go at least a little
below the trend line during a sharp sell-off
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to find information.
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It needs to know if there will be more sellers
or more buyers.
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Most of the time, there will be more buyers
and the bull trend will continue.
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7.
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Re-adjust your trend line after each break
After a trend line break, the chances are
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high that the area will get tested after a
pullback.
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Depending on market conditions, the test can
be followed by the trend continuing in the
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initial direction, in which case you must
re-adjust the trendline with the new swing
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created.
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Prices don't usually move in a uniform fashion,
and since trendlines account for both time
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and price, they move along the price and time
axis.
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This means that any acceleration or deceleration
of the trend requires adjustments to the trendline.
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To decide whether a trendline should be adjusted,
or whether it has been definitely broken,
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consider how the price moves within a trend.
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During an uptrend, for example, the price
makes higher highs and higher lows.
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As long as that keeps occurring, if the price
moves below the trendline it doesn't necessarily
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mean the trend has ended, the trend line just
need to be adjusted.
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8.
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Only draw trend lines when it makes sense
The reality is that not all trend lines have
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the potential to generate a trade.
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The best trend lines are the most obvious
ones.
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Look for every swing point that you can find
and see if there is an earlier one that can
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be connected with a trend line, and then extend
the line to the right and see how price responds
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when it penetrates or touches the line.
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You don’t want to have unnecessary lines
on your chart when trading, because you don’t
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want distractions.
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Also, you need to focus on the bars and see
how they behave once near the line, and not
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focus on the line itself.
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As a trend progresses, counter trend moves
break the trend lines and usually the breakouts
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fail, setting up with trend entries, as we
discussed before.
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Each breakout failure becomes the second point
for the creation of a new, longer trend line
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with a new slope.
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The point is that you should never try to
force a trend line to fit.
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If a trend line doesn’t fit well, it’s
probably best to move on to another pattern.
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9.
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Higher time frames trend lines are the most
important lines
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The longer a trend line is respected, the
more important it becomes.
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A trend line that extends over two weeks will
always be considered more important than a
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level that only extends on the course of a
trading session.
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To get the very best results with trend lines,
I prefer to use higher time frames, like H4
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or D1 charts.
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Most large banks and institutions are only
watching those larger time frames.
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So it would make sense to look at trading
these yourself, to be in line with the traders
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who actually move the markets.
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Another reason why I prefer to use higher
timeframes for drawing trendlines, is because
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of the reliability it gives you.
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Compared to the lower time frames, the H4
chart will cut out all of the noise that comes
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with trying to draw a viable trendline.
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10.
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Use trend line channels to take profit when
buying/selling near the trend line
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A trend channel line is on the opposite side
of the price action from the trend line and
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has the same general slope.
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In a bull trend, for example, a trend line
is below the lows while a trend channel line
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is above the highs, and both are rising up
and to the right.
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A trend channel line is a useful tool for
fading a trend that has gone too far, too
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fast or to take your profit if you entered
a long position around the trend line.
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Until next time.15801
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