Commander in Pips: We’ve learned the basics things about different types of lines. We even had advanced talks about them, and also we’ve investigated how lines could be traded in general. So I offer you to make some compact summary about all of this – just to put in order your knowledge.
Pipruit: This is very good idea, because there was a lot of information in the current chapter, and it was very important, thank you.
Commander in Pips: So, let’s do this.
Support & Resistance
1. When the market reaches some level above it, that does not allow it to move higher, and turns to the downside – this particular level become a resistance. After a move lower, the market reaches some level below it that gives it support and turns from this level to upside move again. So, this level becomes a support. In fact, the market creates resistance and support levels over time during up moves and down move;
2. Support and resistance are not precise numbers, they are more areas rather. And the larger your time frame, as wider this area is;
3. It’s enough even single point to draw support or resistance line, but the more points are lay on the line - all the better. Support and resistance lines are horizontal. You may use a simple line chart built by close prices – to negate splashing among high or low prices and reduce noise in estimation support or resistance levels.
In fact trend lines are very similar to support and resistance lines, but usually used during directional moves of the market – up or down. In other words, trend lines usually have some slope; although there are horizontal trend lines exist also. The major difference between support and resistance line and trend line is as follows: to build support or resistance area you need just one point. For any trend line you need at least two points (three is better).
There are three major types of trend lines:
1. Upward trend line – uptrend
Uptrend line suggests appearing of higher lows from price movement. It always draws and stands below the price action. This line is some kind of support line that we’ve talked about in the previous chapter, but with an upward slope. To draw an uptrend line you need to link well-recognizable lows or support areas. Just find two major bottoms and connect them with line. So, you’ve got your upward trend line!
2. Downward trend line – downtrend
Downtrend line suggests appearing of lower highs from price movement. It always draws and stands above the price action. This line is some kind of resistance line that we’ve talked about in the previous chapter, but with a downward slope. To draw a downtrend line you need to link well-recognizable highs or resistance areas. Just find two major tops and connect them with line. So, you’ve got your downward trend line!
3. Horizontal trend line – Sideways trend.
This is a bit specific price action and word “Trend” itself is not very suitable for this purpose, because trend suggests some acceleration to upside or downside – as we said either higher lows (upside acceleration) or lower highs (downside acceleration), but particularly this feature absents in sideways move. Usually this kind of price action named as “Consolidation” or “Ranging”.
So, to draw a channel you should draw the parallel line with the same angle as an initial trend line. If we talk about an uptrend that is based on lows – then you should draw the parallel line by highs. For a downtrend, that is based on highs – parallel line will be based on lows.
1. To draw an Up Channel, the market has to form higher highs and higher lows with the same speed;
2. To draw a Down Channel, the market has to form lower highs and lower lows with the same speed;
To draw any channel you should follow the procedure:
1. Draw the uptrend/downtrend, according to rules, that we’ve pointed in previous part (trend lines);
2. Clone it – draw another one with the same angle (parallel), adjust it length to the length of potential channel;
3. Drag it to most recent high/low;
4. If this is really an ascending/descending channel – then all previous highs/lows should lay with solid accuracy on dragged line.
5. Don’t fit it forcedly to market action!
When you draw a channel – lines have to be parallel to each other. In general, the bottom line of the channel is treated as support while the upper line – as resistance. Although there is an approach exists that tells that you may buy from lower border of the channel and sell from upper border we do not recommend making trades purely on any lines - trend lines, support/resistance or channels.
Basic rules that could be applied to any lines – support/resistance, trend lines and borders of channels:
1st rule remains intact – If market holds above/below the line and has not closed below/above it but just insignificantly pierced it (with candle shadows), more probable that it still valid. So, Close price is your first assistant.
2d rule - the longer time line is forming the more obvious it becomes – then the more probable the appearing of a stop licking pattern.
3d rule - to not been trapped with stop licking (i.e. Wash and Rinse) you may act in two ways – place your stop-loss order a bit deeper or wait until after the appearing of a stop licking pattern as a confirmation of the line’s strength and further upward/downward market move. After you will see, that Stop licking pattern completed – you may enter in corresponding direction.
4th rule – Stop licking is a fast pattern, so if the market has broken a Line’s level (i.e. close below/above it) and holds there for 3 periods (i.e. 3 bars/candles) or more, then probably this level has been erased by market action and is not valid any more.
5th rule - When price breaks the support line - later it could retest it and this area can act as resistance. The same is true for resistance line – after breakout, it could act as support if market will return and retest this area.
6th rule - The more often price tests the level – the weaker it becomes (good applied to support/resistance, partially applied to trend lines and channels).
7th rule - The longer some level holds, the stronger could be the move after true breakout of this level.
8th rule - The longer your time frame – the wider the support/resistance area.
9th rule - You should never adapt trend or channel lines to market behavior. If these lines do not fit, then it’s just not reliable and inappropriate – do not force it.
Trading the lines
We strongly do not recommend to use any line types as a single context for trading. You should use lines as an additional tool in overall trading plan and trading context.
In general there are two possibilities to apply the lines in trading – when line holds or when it broken by the market. First scenario is trading of a bounce or pullback, second scenario – is trading of breakout.
The major task is to shift the probability in our favor. So, using the confirmation and “proper entry” after the bouncing from the line is a tool of shifting probability in our favor. The point is that the market itself shows us the strength of some line, with price bouncing from it. You should open a position after the bouncing – with this approach you avoid loss in numerous situations when the market runs through the line as push of gangsters and breaks the line.
Our philosophy here is J. DiNapoli proverb: “Loss of opportunity is preferable to loss of capital!" So, although sometimes entering the market in anticipation of a breakout could lead to profit – this is more of a kind of gambling, because you never know will it be true breakout or false. This is even more dangerous due to possibility of stop licking appearing. That’s why we recommend trading breakouts after a pullback to the broken line after the breakout has happened. Our way definitely leads to missing some trades (because market not always returns back to line), but at the same time this approach has a lot of advantages:
1. You do not need to guess about “solid move after breakout”
2. You have a confirmation from the market by failure to return right back above/below the line
3. You have a better opportunity to place stop loss order and your stop loss order can tighter to significantly reduce risk.
4. Very often your entry level will be even better compared to entering with the initial breakout.
5. All you need to succeed in this kind of trades – is a bit patience to wait the right moment to enter the market.