Rule-based trendlines: Forex Trading

When the forex trading market is choppy and prices rise and fall without a trend or obvious range, there’s a technique for scalping or day-trading those little microtrends. It’s called the rule-based trendlines technique.

Below is the current five-minute chart of the U.S. dollar versus the Canadian dollar, currency pair USD/CAD:

On this chart, the price is moving in microtrends: little moves up or down in a directionless market. The yellow support-resistance line, although briefly respected by the price action, is nevertheless broken repeatedly. The grey line, the 200-period moving average, is almost horizontal, emphasizing the lack of trend.

It’s one of the most difficult markets to trade. Nevertheless, the rule-based trendlines technique can enable profitable trades, even in this.

In its most basic form, the rule-based trendlines technique utilises no indicators beyond the price bars themselves. It’s based entirely on trendlines on an intraday chart, generally of five-minute or fifteen-minute duration.

The method for an uptrend:
1. Draw a trendline on the chart connecting the lowest low to the next lowest low that precedes the next reaction high.
2. Enter the market long on the third touch of the trendline.
3. Exit on the break of the trendline.

Below is the same chart, with a bullish trendline drawn as support along one microtrend:

The pale vertical line marks the price action’s third touch of the bullish trendline and therefore the long entry point, at roughly 1.0188. The position would be held until the price action broke beneath the bullish trendline, which occurred at roughly 1.0210, for a gain of 22 pips—not great for scalping but not horrid, either.

More risk-accepting traders may wish to enter at the second touch of the trendline rather than the third. Such an entry on the trade discussed above gains 6 pips with the entry at 1.0182.

The method for a downtrend is the same, only reversed:
1. Draw a trendline on the chart connecting the highest high to the next highest high that precedes the next reaction low.
2. Enter the market long on the third touch of the trendline.
3. Exit on the break of the trendline.

Below is the chart again, with the next trendline drawn:

The pale vertical line has been moved to reflect the short entry point, at roughly 1.0205. Again the exit would be at the break of the trendline, in this case at 1.0173, for a gain this trade of 32 pips and a cumulative total of 54.

It’s interesting that the third trendline, which is again bullish, signals a long entry before the exit point is reached for the second trade. Below is the chart yet again, with the third trendline drawn in blue for easy differentiation and the vertical line moved to reflect the third entry point at 1.0166:

In such a case, traders should exit the second, short trade while entering the market for the third, long one, adding 7 more pips to the cumulative total.