To be able to use the signals resulting from the trend line break or from extremum, is only an introduction to work out a winning trading strategy. It is, however, a very important introduction. A proper choice of a moment to make a transaction, resulting from previously adopted rules is a fundament of all more advanced analytical techniques. Although many of them are not based on the trend line break but on signals coming from indicators or oscillators, basic rules remain the same. Opening or closing of a position is always possible under some conditions and is not an emotional decision resulting from an unanticipated rate movement. Such an attitude enables to remain objective to a larger degree and to make rational decisions.
A trend line break
A trend line break is considered to be one of the strongest trading signals. There are no one hundred percent sure signals on the capital market, so it is also very important to have other occurring circumstances in mind. Some factors may increase or decrease the importance of a signal:
1. Volume during the break
A high volume during a day, on which a price broke a trend line is the confirmation of the importance of a signal. It means that many traders changed their attitude towards the market that day and it isn’t very possible that the previous tendency will return.
2. The scope of a price change
The stronger the trend line break is, the more important a given signal is. The price may break the line by 0.5% or a few percent during a day. Obviously, in the second case the signal is more important, as it definitely confirms traders.
3. The scope of a daily price change
The importance of a signal rises with the increase in the scope of a daily price change from opening to closing. If a long candlestick appears on the chart, the trend line break is much more important than if it happened during a day with a low daily price change. It is clear that traders don’t act emotionally but changed their attitude towards the market for good.
During a few days after the trend line break or important support or resistance, the price can make a return movement in the direction of a broken level. In general, after this event, increases and decreases in price level occur very fast again according to a previous signal. It is very often a very advantageous situation to open a position.
A return movement doesn’t always happen after the trend line break or exremum. At the same time, while waiting for this movement to take a position, it is very easy to overlook a very good opportunity to make some profit. A decision whether to open a position just after the signal appears or whether to wait for a return movement may depend on, for example, oscillators’ behavior. It is more possible that it appears on an overbought or an oversold market, and if oscillators remain in neutral zones, it may not appear.
Penetration and traps
Small and short-term trend line breaks happen quite often and they are called penetration. Afterwards, the present tendency continues. It may very often occur, for example, during a session when a line breaks and the price rises beyond it again by the end of the day. In such situations, additional techniques confirming the importance of signals should be applied.
While drawing a line on historical data, such situations should be often ignored, and the line should go through previous and later highs and lows.
So called traps are a different situation. They mean a certain line trend break, after which the reversal of the trend is anticipated. After a few or a dozen of days it turns out that the signal was misleading and the previous trend comes back on the market. In such a case, a newly opened position should be closed quickly to minimize losses and one should be aware of the fact that the part of signals coming from the technical analysis will always remain wrong.
The notion of correction is closely interconnected with the trend line break which directly influences the above mentioned trend degrees. The correct description of a trend direction of particular degrees at the moment of the trend line break is crucial to understand the present market situation.
The trend line break means a trend change of the same degree and the beginning of a trend correction of a higher degree. For example, a break of a short-term trend line means:
- short-term trend reversal
- medium-term trend correction
- no meaning for a long-term trend
Basic trading techniques
Among four most popular techniques of adopting position, based on the trend line break and extremum, are the following:
1. Opening or closing position upon the trend line break
2. Opening or closing position upon the last extremum break
3. Opening position during a return movement
4. Opening position after the return movement