A Trend-Line-Driven Entry Strategy

04/05/2012 6:00 am EST

Focus: FOREX

Richard Krivo of DailyFX.com reviews two FX-inspired examples that illustrate how to use trend line support and resistance to find valid entry points for long or short trades.

As with virtually any trading scenario, we must first determine the direction that we need to trade the pair for the greatest likelihood of success.

By looking at the four-hour chart of the GBP/USD below, there are several reasons we know that we want to go long (buy) the pair. Price action is above the 200-period simple moving average (SMA) and is pulling away from it; the pair has been making higher highs and higher lows (green lines), which indicates an uptrend; and, at the time of this chart, the GBP was the strongest currency and the USD was one of the weaker currencies.

All these point to a buying opportunity. But when do we enter the trade?

Let’s take a look at the trend line:

chart
Click to Enlarge

We can see that price action has come in contact with trend line support at several points (the blue boxes. Since price has tested and respected the trend line at more than three points, we know that this trend line is valid.

Our entry strategy to buy this pair using trend line support will be to wait for price to trade down to the trend line, or into the “buy zone.” If price trades into the zone and stalls and a candle does not close below trend line support, just as in our “blue box examples,” we can take a long position on the pair with our stop just below the trend line or just below the lowest wick that penetrates the trend line.

The trader could exit the trade if price reaches resistance, the previous high, or by employing a simple 1:2 risk/reward ratio.

See related: Make Sure Risk/Reward Is on Your Side

Now let’s take a look at a four-hour chart of the USD/CHF as an example of selling against trend line resistance in a downtrend:

chart
Click to Enlarge

This trading scenario will be virtually the opposite of what we did in the previous buy example.

We want to sell this pair, as it has been making lower lows (red lines) and lower highs; price action is below the 200 SMA and pulling away from it; and, at the time of this chart, the USD was weak and the CHF was strong.

Again, price action has tested the resistance line at several points (blue boxes), so we know the trend line is valid. In this example, we would wait for price to trade up to trend line resistance in the sell zone. As long as a candle does not close above the trend line, we would sell the pair with a stop just above the trend line or just above the highest wick to penetrate the trend line.

The trade could be closed should price reach the previous low, or we could use a 1:2 risk/reward ratio to exit the trade.

See also: 6 Reasons to Exit a Forex Trade

By Richard Krivo, trading instructor, DailyFX.com

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