The Right Way to Use Lines in Trading (Part 1)

04/13/2009 10:38 am EST


Timothy Morge


I have been working with lines as my main trading tool for more than 38 years now. Lines are simple, lines capture the probable path of price well, and lines work over and over and over. My favorite lines are the three parallel lines that make up Median Lines, but I work with all sorts of lines in my trading.

A trader e-mailed this past week asking why I never traded using trend lines or channels. I responded that I use both in my trading, but rarely show these tools because they are not my "bread and butter" tools, the ones I use most often. And that spawned the idea of looking at the same major move in a market with a handful of different line tools. So here we go!

First, let's look at the market structure we're going to use to evaluate the effectiveness of these tools. We'll also see if we can spot any changes in behavior, so we can watch how quickly each of the different tools responds to changes in behavior by the market.

I found a gorgeous swing on a 240-minute bar chart of the euro FX against the US dollar FX chart. Let's take a look at it:

Price is in a gorgeous downtrend, making lower highs and lower lows from mid-December 2008 through late-January 2008, when the downtrend began to slow its pace. Price continued to make lower highs until early February and then it began to consolidate, making higher lows for a two-week period in early February with three slightly higher highs. The price action here is too flat to call it an uptrend.

Then price plunged once, making new lows for the entire move, and when it climbed higher from this new low, it made a series of higher lows and higher highs, and the final higher high broke above the prior swing high of the prior downtrend. This is often a sign that a change in behavior has begun, but you can see on this chart that price did not follow through! Instead, price headed lower to make a lower low for the move.

Note that the size of the swings contracted during this last run lower.

And when price failed to make a new low for the move, it spiked higher and traded above the prior two swing highs—again, a sign that a change in behavior in this market is probably at hand.

More tomorrow in Part 2.

Timothy Morge

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