Welcome to this fifth monthly feature-length blog post sponsored by the Trendline Mastery home-study course and membership service, available exclusively from Forexmentor.
Last month’s article was entitled “Drawing Tend Lines On Things Other Than Price”. In that article, we showed how the Relative Strength Index (or RSI) is unique among technical indicators by virtue of being amenable to Trend Line (TL) analysis, which we had previously reserved exclusively for the price panel. We also showed in that article that TL Analysis on the RSI panel can often show you things that are not possible to see on the price panel. Of course, the two variants of TL Analysis applied together can produce optimal insights into trend, momentum, support/resistance and reversals.
In this month’s installment, we’re going to bring you a case study example showing how TL Analysis applied only on the RSI panel (again, using the default period setting of 14 on all timeframes from highest to lowest) was able to provide the following functions on a specific trade:
- Identifying a strong multi-timeframe trend;
- Identifying a corrective setup;
- Providing a real-time trade entry trigger;
- Monitoring an open position through to completion.
If there was ever a case to be made for including any one technical indicator in your chart template, for the purpose of facilitating TL Analysis, then RSI is clearly the only choice. Simply put, you cannot replicate its functionality in this regard with any other indicator, be it MACD, Stochastics, CCI, and so on.
The pair that we’re going to look at for this case study is the AUD/NZD cross, for the Daily session of Wednesday, May 11th, 2016, with a short bias.
One of the neat things about TL Analysis, whether applied on the price panel or the RSI panel, is that once you get good at it (through sufficient practice), it takes hardly any time to do. Literally from scratch, you can have all six of the core timeframes (Monthly down to 15m) marked up to tell you whether you’re dealing with a strong top-down trend reading or not.
So what we’re going to do for this case study is pull up all six charts comprising the core template, and see what TL Analysis on the RSI panel had to say as of May 11th for the pair of interest. We don’t have to worry about the fact that these chart annotations were done after the fact, because in every single example, the trend line identified was specifically in force to the live edge of trading identified on each chart, at the time the trade setup and entry triggers materialized.
So let’s get to it then, starting with the Monthly chart.
Before we do, though, please keep an important consideration in mind: As of the point in time this case study was prepared (into May 12th, 2016), all RSI trend line analysis we are presenting was as shown on the various chart captures we’ve included. Depending on when you read this article, which may be anywhere from days to weeks after the fact, that trend line analysis may have changed, resulting in readings different on your own charts in real-time. Please keep in mind that with the passage of time, any sharp and/or sustained price reversal to the upside could have the effect of changing the RSI readings when you next look at them. Just know that as of the date this article was prepared, the intact trend line analysis at that time was exactly as we’ve shown it here. With indicators, the only readings that count were the ones available in real time.
At the dashed vertical line we’ve drawn through the monthly bar for May, 2016, we can see that RSI is in the process of breaking down and through a Demand TL which connects back to a RSI Swing Point on the monthly bar of March, 2015 (connecting to higher lows for October and December 2015, and February, 2016). Of course, the price panel itself indicates a much longer term downtrend from early 2011 onwards, but the bearish RSI trend line break for the current month (as of May 11th) did indicate also a short-term reversal within that longer term downtrend. As long as RSI was pointing lower below its own recent Demand trend line break, we could say that the directional bias on this timeframe was bearish into May 11th.
Where we’ve drawn a dashed vertical line on this timeframe as well (the Weekly bar for May 9th, 2016), we can see that RSI had recently broken down and through a prior Demand trend line, going back to the low for the week of January 11th, 2016. And, as was the case with the Monthly chart referenced above, as long as RSI continued trending lower below that broken trend line, we had ample reason to call a downtrend in progress on the Weekly chart. So at this point, we’re two-for-two: RSI analysis showed recent trend line breaks on both of the two highest timeframes concurrently.
On the Daily chart shown here, we’ve dropped a dashed vertical line through the May 11th juncture. It is interesting to note that the prior day’s session generated an Inverted Hammer candle, which would easily fulfill the function of a top reversal signal ending the rally from the low of May 6th. If we then consider the trendline in force on the RSI panel to May 11th, we note a Supply (aka Falling Resistance) trend line dating back to a RSI Swing Point High for March 9th. As is so often the case with trend lines, the strongest ones are those which allow for multiple connection points on the trend line; in this case, there were at least three (arguably five) establishing that the trend line in question as valid and believable.
The other interesting point about this particular example is that it reflects the concept of RSI divergence: From the first to last connection points on the trend line, we see RSI trending down. But during the equivalent span of time on the price panel, price is making not lower highs, but rather flat highs. When you have line studies on a price panel and an indicator panel not concurrently sloping in the same direction over a significant span of time, you have divergence. To be specific about it, this chart view sports a so-called Hidden Negative Divergence: flat highs on price against lower highs on RSI. Regardless of the jargon, the trend direction on RSI here is clearly bearish, and that means all three of the highest timeframes we’ve looked at thus far are in agreement; the trend bias seems to be down.
The dashed vertical line on our 4hr chart extract shown here is for the timestamp of 20:00 (8pm) GMT on Wednesday, May 11th. The main technical event of interest on the RSI panel lies a few bars to the left, in the form of the circled downside break of a corrective Demand trend line, which commenced from the low of 8am GMT on May 9th. How could we have know at the time that this trend line was corrective rather than trending? Simple: the preponderance of trend line analysis on all of the higher timeframes, as we have already shown, was bearish at the time.
In any event, with both price and the RSI indicator trending down to the right-hand side of the chart, there is little doubt as to what the directional bias is by the time we get to the live edge of trading at the dashed line on the right. Not only that, but with all four timeframes we have thus far looked at in agreement, we have a powerful Quad Screen trend reading. This is the formula we are always reflecting in the bi-weekly Forecast Pack PDF reports we post to the Trendline Mastery Traders Club site.
At this point, we drill down further, leaving the upper timeframes behind for a closer look on the intraday timeframes. The dashed vertical line on the above chart is drawn through the 60m bar for 22:00 (10pm) GMT on May 11th. Before the close of that bar, RSI made two level highs, allowing us to draw the horizontal resistance line shown. This is another example of RSI divergence: lower highs on price matched with flat highs on RSI. So, in the context of a higher level downtrend, we see over a shorter time interval on the 60m chart, a recently completed resistance event, which is certainly far more likely to have bearish implications than not.
The timestamp of interest noted on the sixth and final timeframe in succession which we’re including within our top-down review is on the vertical dashed line at 22:30 (10:30pm) GMT on May 11th. The RSI panel at this point is interesting because it shows us two different trend lines, each of which is useful in different ways. The longer of the two line segments is a Supply trend line which aligns well with the horizontal resistance line we just drew on the 60m chart, not to mention the preponderance of bearish trend readings on all of the higher timeframes. The short of the two line studies is a Demand trend line, which outlines a short-lived corrective rally on the 15m chart. This latter element provides an early warning of a pending setup, because, as we know, as trend traders on the short side, we pretty much always want to be selling a rally top of some kind.
So RSI trend line analysis has thus far given us a strong top-down trend reading, but as we look to the 15m chart, we see it fulfilling another function, that of generating a setup. The only thing left to do at this point is wait for RSI to break its own corrective trendline, which it does on the close of the 22:30 GMT candle. And that, in turn, means we have an entry signal on the short side on the open of the next bar, or 22:45 GMT. The open price of that bar was 1.0805, and the highest high on the same bar was 1.0811, which means that the drawdown (ignoring spread) was only 6 pips. Thereafter, price collapsed quite convincingly, without at any time coming close to triggering the Initial Protective Stop. So with a corrective trendline break providing the entry trigger, we can count up three different functions that RSI trend line analysis has correctly and efficiently provided us.
After getting risk out of the trade by trailing the Initial Protective Stop to breakeven on attainment of floating profit of 15-30 pips, the only other thing that was left for us to do was determine an exit strategy. Here, too, RSI can be of assistance. Simply hold on in real time (if you have enough hours available in the day to monitor open positions) until RSI crosses a bearish trend line in the upwards direction on no lower than the 60m chart. Though we didn’t show that even on our 60m chart annotation above, it did occur on the close of the 2:00am GMT bar for the following day, May 12th. From the open price mentioned above to this signal to close the position (@ 1.0760), the profit potential on the Day Trade was +45 pips.
Of course, there are always a variety of other exit strategies available to suit your own personal preferences in terms of scale of profit target, time in the trade, and so on. Those strategies are beyond the scope of this article to describe; suffice to say that whether one had pursued the above trade setup as a Position, Swing, Day or Scalp trade, there was absolutely no reason not to do better than an absolute worst-case scenario of a breakeven stop.
In this latest instalment in our monthly Blog series for the Trendline Mastery Trader’s Club, we have shown how Top-Down Trendline Analysis applied on the RSI panel can fulfill all of the most important technical aspects of signaling a high-probability trend trade, including establishing a trend bias, identifying a setup, entering the trade, and managing an open position. Just think: Not a single one of those aspects required reference to other indicators, chart patterns – or even price itself for that matter! And the end result was a correctly executed trade attempt into the trending direction. The nicest aspect about all of this is that when you have taken the time to understand the underlying trend-based chart technicals as we’ve shown here, the entire analysis can be completed in a tiny fraction of the time it has taken you to read this article. Not bad!
In conclusion, I’d like to thank you for joining us here today. I sincerely hope that this blog article has provided you some useful insights into the topic of trendline analysis for Forex trading. If I can ever answer any questions you might have, please see the Member’s Forum available at the Trendline Mastery membership site (www.forexmentor.com/trendline), or send us an email message (with the subject header “Question on TL Analysis”) to: email@example.com. Please also be sure to follow our Twitter feed (@fxmtrendline).
I am well known for my ability to deliver clear and concise explanations of complex trading topics. I am the force behind a series of comprehensive, yet practical, forex courses and training programs at Forexmentor. (Forexmentor links to www.ForexMentor.com.)
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