An effective way to use RSI trendlines!

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An effective way to use RSI trendlines!

In this article i want to share with you an effective way to use RSI trendlines to trade with the trend or a reversal. You already know from my previous articles that I use RSI to identify an overbought or an oversold condition. We will use again RSI for this job but now I am going to saw you how to draw simply and fast trendlines in RSI to have an extra confirmation and confidence for your online binary option trades.

Let’s go to the first screenshot. It’s from EUR/USD currency pair.

As you can see in this chart we don’t have many indicators, only our 8 period RSI for confirmation,it’s almost naked trading. Now, look at the screenshot.We have two red horizontal lines from previous supports which create a support area in this spot.When the price comes closer to this spot we should wait for a reversal.If you are a short-term trader the entry is very important, so many traders asking which is the right one. Should we wait for the price to hit the first red horizontal line?Maybe the second? We can use RSI trendlines for this reason. Look at the RSI. I drew a red trendline. As you can see the value in RSI makes lower- highs. We have a high in the beginning of the trendline, after that the value is moving down and makes a new high lower than the previous. The only thing we have to do is to connect the highs(high and lower-high) and our trendline is ready. Now, notice the behavior of the price and the behavior of the value in our 8 period RSI indicator.They agree so we don’t have a divergance. Notice that the value in RSI every time it hit the trendline makes bounces.The trendline acts as a resistance.Look at the call arrow in the screenshot. It’s the spot I took a call trade.The price hit a support level, as I said before and in this candle notice that the value in our RSI breaks the trendline. This is a reversal signal.

Let’s see more examples.

In the second screenshot we have again lower-highs of the value in our RSI and a support area in the chart, so we take a call. In the third screenhot we have the opposite condition. Look at the chart, we have a resistance in the red horizontal line and our RSI makes higher-lows, a sign that that the price is moving up now. When the price hit the resistance (the red horizontal line) notice the behavior of our indicator. The value breaks the trendline in the blue box. This is our confirmation and we take a put in this case.

You shouldn’t chase the trades, let them come to you. RSI is an indicator and just follow the price. You should be patient and wait for a clear break of the trendline. Maybe sometimes, you should wait to see how the first candle acts after the reversal and after that take your trade. Don’t forget overbought/oversold areas.

RSI Trendline Strategy – an Effective Reversal Strategy

The RSI Trendline Strategy is essentially a reversal strategy and it makes use of the RSI indicator in an unconventional way. The Relative Strength Index (RSI) indicator was developed by J. Welles Wilder and it’s a momentum oscillator that measures the speed and change of price movement. The RSI oscillates between 0 and 100 and it’s often used to measure overbought and oversold conditions in the market, divergence or it can be used to identify the general trend. Basically, the RSI is analyzing the total number of down periods versus the total number of up periods and plots the average on the RSI curve. There are many different techniques for using it, but it can be altered depending on each trader’s needs.

RSI Trendline Strategy Setting

According to Wilder the default RSI settings should be 14 periods, but in our proposed strategy we’re going to use the 20 periods as our RSI settings. The reason why we’re going to use the 20 periods is because 20 is multiple of 200 periods, and the 200 periods carries a big influence and it’s a big psychological number often used by the smart money to define an uptrend or a downtrend. We don’t want to use a bigger period because it can signal the beginning of a new trend too late, but we neither want to use a faster period because it can generate a lot of false signals.

We use the RSI indicator to show us if the prevailing trend has ended and a new trend is underway, but as stated above, we’re not going to measure the overbought/oversold conditions or as a crossover system, we’re going to take it one step further and look for a break in momentum of the prevailing trend. What I mean by this is that we’re going to look at the changes in prices relative to the changes in the peak and the valley that the RSI indicator will generate.

RSI Trendline Strategy

As the above chart suggests the RSI-Trendline strategy works best on the 1 hour time frame but with its applicability can be used on any time frame. The rules of the system are straightforward, we only need to connect the most recent RSI peaks or valleys with a trendline and a breakout of the TL will warn us that the market has lost its steam and the prevailing trend has lost its momentum.

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There is one more condition that needs to be satisfied in order to enter a trade, we need for the price to still be trading below its trendline, so we’ll need the RSI trendline to be broken, but the price to still be trading below its trendline. This is the most important principle in order for the RSI-Trendline strategy to work because it tells us there is also a divergence between momentum and price. Momentum always goes ahead of price and that’s the reason why this strategy can yield a great return.

RSI Trendline Strategy – Sell Setup

In the above chart, we can have a representation of how a short setup would look like. In terms of stop loss level, we’re always going to use the candle on which the RSI broke its trendline, so in the case of our short setup our SL would be above that candle. In terms of profit target, we’re going to use the RSI again and wait until it’s changing momentum in the opposite direction.

How to Draw Trend Lines Perfectly Every Time [2020 Update]

Trend lines have become widely popular as a way to identify possible support or resistance. But one question still lingers among Forex traders – how to draw trend lines?

In this lesson, we’ll discuss what trend lines are as well as how to draw them. I’m also going to share a secret way that I like to use trend lines to spot potential tops and bottoms in a market, so be sure to read the lesson in its entirety.

What Are Trend Lines?

As the name implies, trend lines are levels used in technical analysis that can be drawn along a trend to represent either support or resistance, depending on the direction of the trend. Think of them as the diagonal equivalent of horizontal support and resistance.

Exclusive Bonus: Download the trend lines PDF cheat sheet to learn helpful tips and techniques on how to draw these levels and use them to find setups.

These trend lines can help us to identify potential areas of increased supply and demand, which can cause the market to move down or up respectively.

Let’s take a look at a trend line that was drawn during an uptrend.

Notice how in the GBPUSD daily chart above, the market touched off of trend line support several times over an extended period of time. This trend line represented an area of support where traders can begin to look for buying opportunities.

Now let’s take a look at a trend line that was drawn during a downtrend.

Similar to the GBPUSD uptrend in the first chart, this AUDNZD downtrend touched off of our trend line several times over an extended period of time. The difference is that the trend line above represents a downtrend, during which time it acts as resistance, giving traders an opportunity to look for selling opportunities.

How to Draw Trend Lines Correctly

Now that we have a good understanding of what trend lines are, let’s go over how to draw them.

The very first thing to know about drawing trend lines is that you need at least two points in the market to start a trend line. Once the second swing high or low has been identified, you can draw your trend line.

Here is an example of the first two swing lows that have been identified.

Notice in the chart above, we have two main points at which we can start to draw our trend line. Once this level has been established, we can start to look for bullish price action to join the rally.

Sure enough, just a few weeks later a bullish pin bar emerged at trend line support.

The bullish pin bar above provided a signal to traders that the trend line was likely to hold. This gave traders an opportunity to buy at support to join the rally.

3 Keys to Drawing Trend Lines Effectively

There are three very important keys to drawing effective trend lines.

  • The higher time frames will always produce the most reliable trend lines, so start there and work your way down
  • Most trend lines you come across will have some overlap from the high or low of a candle, but what’s important is getting the most touches possible without cutting through the body of a candle
  • Never try to force a trend line to fit – if it doesn’t fit the chart then it isn’t valid and is therefore not worth having on your chart

Let’s take a look at each of these in greater detail.

Use the Higher Time Frames for Drawing Trend Lines

Just about everything I do in the Forex market begins on the daily time frame and drawing trend lines is no exception. One reason I prefer the daily time frame for drawing trend lines, besides the fact that I do most of my trading from this time frame, is that it represents an extended period of time.

This brings me to a very important rule regarding trend lines. The longer a trend line is respected, the more important it becomes. A trend line that extends over two years will always be considered more important than a level that only extends the course of two weeks.

Here is a great example of a trend line that was drawn from the daily time frame.

In the GBPCHF daily chart above, after the second swing low was made we could have drawn our trend line. Notice how the market formed a bullish pin bar at the third touch from this trend line. This is a perfect example of the type of buying opportunity a trader would look for using trend line support.

Another higher time frame that I like to use to draw trend lines is the weekly chart. This time frame is great for identifying potential targets during uptrends or downtrends on the daily time frame.

Here is a great example of how a weekly trend line on CADCHF can be used to identify a potential target.

The chart above shows a weekly trend line that can be extremely useful to identify a potential target for CADCHF. The daily time frame is in an uptrend at the moment, so this weekly trend line would give us a great starting place to look for a potential profit target.

Trend Lines and Overlap

One of the most common questions when it comes to drawing trend lines is, should they be drawn from the high/low of a candle or from the open/close of the candle. The answer to this question depends on the trend line.

It’s very rare to find a trend line that lines up perfectly with highs or lows. Similarly, it’s rare to find a trend line that lines up perfectly with the open or close of each candle.

Let’s take a look at an example

Notice how the trend line above does not perfectly line up with the highs of each candle, nor does it line up perfectly with the open or close of each candle. This doesn’t mean that the trend line is invalid. What’s important here is that the weekly chart above never closed above this level.

The most important part of any trend line is to get the most touches without the level cutting off part of a candlestick. If you find that a trend line cuts through the body of a candlestick, then the trend line is likely not valid.

Never Try to Force a Trend Line to Fit

This is perhaps the most common pitfall Forex traders make when drawing trend lines. We call this “curve fitting” and it happens when a technical trader is so convinced that a level should exit, that the trader begins to try to make the level fit the price action on the chart.

This brings me to the most important part about drawing trend lines, or any support or resistance level for that matter. The best trend lines are the most obvious ones. So if a trend line doesn’t fit well, it’s probably best to move on to another pattern.

How to Use Trend Lines to Spot Potential Reversals

As promised, I’m going to show you a way that I like to use trend lines to determine the strength of a trend. Moreover, this method can help you spot potential reversal points in the market.

At this point in the lesson, you know that a trend line can be used to identify potential buying or selling opportunities. But this only works as long as the market continues to respect the trend line as support or resistance. So what happens when the market no longer respects the level?

This is where you have a chance to trade a market as it makes a turn from a major swing high or low. Below is an example of a market that broke trend line support and then retested that same trend line as new resistance.

We can see in the GBPCHF daily chart above, that the pair had respected a trend line for some time. However once the market broke trend line support, it quickly retested former support as new resistance. This retest gave traders the opportunity to sell the pair, which would have resulted in a substantial gain over the next several days as the market sold off.

One thing to note about using trend lines in this way is that it works best when you have a really clean trend line with three or more touches. The more obvious the trend line is, the better this strategy will work.

We can also use this strategy to identify a bullish reversal.

Notice how shortly after breaking trend line resistance, the market came back to retest the trend line as new support and formed a bullish pin bar in the process. This gave price action traders an opportunity to buy just before the market rallied for 800 pips.

This is a great way to use trend lines to spot potential reversals in the market. It is without a doubt one of the best ways to catch a big move as a market changes direction.

Summary

I hope this lesson has given you a better understanding of how to draw trend lines and how they can be used in the Forex market.

We’ve covered a lot in this lesson, so let’s recap some of the important points.

  • Think of trend lines as the diagonal equivalent to horizontal support and resistance levels
  • Trend lines can help traders identify buying and selling opportunities that occur within a strong trend
  • The higher time frames will always produce the most reliable trend lines, so start there and work your way down
  • Most trend lines you come across will have some overlap from the high or low of a candle, but what’s important is getting the most touches possible without cutting through the body of a candle
  • Never try to force a trend line to fit – if it doesn’t fit the chart then it isn’t valid and is therefore not worth having on your chart
  • A break and retest of a trend line that had three of more touches can often mean a reversal in the market and a potential buying or selling opportunity

General FAQ

A trend line is a diagonal support or resistance level on a price chart. It’s often used to identify support during an uptrend or resistance during a downtrend.

Start with a prominent high or low on a higher time frame such as the daily. From there, look to see if you can connect a trend line with the subsequent lows (for an uptrend) or highs (for a downtrend).

It’s okay if a trend line cuts through a small part of the upper or lower wick on a candlestick. However, as a general rule, a trend line should not cut through the body of a candlestick.

Now I’ve Got a Question For You.

Are you ready to begin using these techniques in your trading?

Then you definitely want to download the free Forex trend lines PDF that I just put together.

It contains the four keys to drawing these levels accurately. I’ve also included examples so you can see exactly how I use trend lines in my trading.

Click the link below and enter your email to download the cheat sheet.

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About Justin Bennett

Justin Bennett is an internationally recognized Forex trader with 10+ years of experience. He’s been interviewed by Stocks & Commodities Magazine as a featured trader for the month and is mentioned weekly by Forex Factory next to publications from CNN and Bloomberg. Justin created Daily Price Action in 2020 and has since grown the monthly readership to over 100,000 Forex traders and has personally mentored more than 3,000 students. Read more.

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