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Friday, March 7, 2008

Dynamic Trendlines

Scaling In for Extra Profits

Often when the market starts trending in a new direction it can be difficult to determine the full extent of the rally and know when to add positions to existing ones or enter new positions during the current rally.

By using Dynamic Trend lines to help us find entry points we can take full advantage of the rally. By dynamic I mean placing new trend lines as the market moves.

On the first GBP/USD 15 min chart I have drawn in the channel lines for the down run and will be looking for either a continuation of the down move or a breakout of the channel to go long.

As we can see the market continued down until it hit the lower support (blue line) established earlier and bounced before stalling temporarily at the top channel resistance line.

Once price broke through the channel resistance we had our first entry long at 1.9833 with our stop at 1.9800 below the channel line and about 10 pips below the last low.

The market rallied and formed a new high at 1.9966 before retracing. At this point I added Fibonacci retracements expecting price to drop to at least the .382 retracement before continuing the rally. As we can see price stalled round the 23.6 retracement area and the question was "where to enter should the rally continue?" and "how high will the market go?"

At this point we are able to add an up trend line (which becomes our support) and draw a channel line running parallel with the last high in the market. The top of the new channel becomes our possible target on the upside in conjunction with the Fib 1.618 target.
Click to enlarge.

On this next chart I have added my first Dynamic trend line which runs parallel to the top (blue) channel line. (For Meta trader users double click the Previous channel line and then drag it across to the new high it will give a new line at the identical angle to the first.)

Once price breaks above this new resistance we can scale in with a second lot or a new entry into the market at 1.9936 with our target still at the fib 1.1618 or the top of the channel line.

By repeating this process after each retracement we wind up with multiple entries in the market. As we can see the Dynamic Trend lines gave us seven entries into the market with the first giving us a return of 327 pips. Our stop loss would be the last low beneath each Dynamic Trend line.

Obviously we need to adhere to good money management principals and not overexpose ourselves in the market. I have not added the final profits but I am certain it would have more than doubled the original 327 pips.

The lower red channel line is the reversal point should price break below this support. Each new retracement and Dynamic Trend Line also becomes the new stop loss point for previous orders.Summary

  1. Establish the original break out point.
  2. Wait for a retracement to draw in the initial Dynamic Trend Line.
  3. Scale in a second order
  4. Place stops beneath the Dynamic Trend line and last low.
  5. Repeat the process until the target is reached or the market takes you out on stop.

6 comments:

Rob said...

I've always enjoyed a technical treatment of market moves. As an old maths major, it's nice to see fibonnaci is still hanging around and doing some good. But I disagree with a purely technical approach. You can argue persuasively that markets are somewhat irrational and so deserve technical treatment, but it's always good to know how to read a balance sheet and income statement, and be up on market conditions and trends in related equities.

Forexman said...

Hi Rob
I agree with that for the longer term traders. I am however strictly a day trader. I seldom stay in the market overnight.

I mostly trade the Euroupean and London trading sessions strictly in the Forex market and find the technicals work very for trades lasting a few hours rather than days weeks or months.

If I went back to equity trading then obviously the long term view and fundamental analysis would play a more important role.

Anonymous said...

Hey Forexman! I love your explanation for the dynamic trendlines. I was looking for one on the net and I think yours is very clear and well explained. I do not understand however how were you able to trace in the first picture the bottom blue trend line, which connects the low from 3 March 14.00-15.00 to the low from 5 March 10.00. Is this a simple copy-and-drag from the top blue trend line? My initial guess was that, as the market was stalling from 5 March 6.00 to 5 March 10.00, you were consistently copying and dragging trendlines from the top blue one, and connecting them with the most recent lows from 4 March 18.00, then 4 March 10.00 etc. In summary you had dynamic trandlines, but in a downtrend, until the market bottomed at 1.9720. Is my view correct or am I missing something?

Thanks again!

Bart

Forexman said...

Hi Bart

Thanks for the comment. Your thinking is almost correct. The bottom blue line is actually my channel line.

As price broke the low of my previous channel, once the new low was confirmed I dragged a line parallel with my down trend line using my new low of 5 March to form the bottom of the new Channel.

Once price broke through the top of the new channel the first trade was entered.

The scaling in started once the new high had been formed allowing the placing of a new trendline at the same angle as the first.

The channel breakout is intergral to the system as it gives a clear signal of a possible reversal.

Anonymous said...

Hi Forexman, it's Bart again. Just for a last explanation: when you say "As price broke the low of my previous channel" your previous channel was the the most recent low before market stalling. Which in the first picture would be the low from 4 March 18.00 hours, is this correct?

I am asking because I have problems understanding whether in terms of Channel you need to refer to the most recent low, or the lowest low.

An I am practicing this exercice on the current AUD/USD 1H chart, can you see the amazing vertical run? :) I made quite a lot of pips on it!

Forexman said...

Hi Bart

Yes you are correct the market was in a tight band of consolidation and that is the low I used for my channel and once price broke that I went short for about 50 pips.

The low of 5 March became the new bottom of a bigger channel.

Happy trading.