Detailed Anatomy of a Top-Down Trendline Based Trade

Welcome to this second monthly blog sponsored by the Trendline Mastery home-study course and membership service, available exclusively from Forexmentor[1]. (Our first monthly Blog article, entitled “What Trend Lines Mean and How They Work” was published in January. We hope you have had the chance to read that article, and if so, that you enjoyed it).

Our plan is to publish these articles once per month, to provide you the opportunity to learn from experienced traders offering practical and road-tested insights into how to apply trendline-based tools and techniques for the purpose of attaining consistently net profitable Forex trading results. My name is Frank Paul, developer and co-presenter of the Trendline Mastery course, along with my project collaborator Peter Bain, who is one of the founders of Forexmentor.com, and the person from whom I first learned about trend lines more than ten years ago now.

Last month’s article was entitled “What Trend Lines Mean and How They Work”.  In that article, we talked about some of the technical considerations involved in properly drawing trend lines, what they can tell us in terms of trend-trading bias, how trend lines often do a better job conveying trend direction than indicators, and how and why it is that trendline annotations applied in “top-down” fashion are the most powerful expression of this form of chart analysis.

In our January installment, we also mentioned that the best way to illustrate Top-Down Trendline Analysis would be with chart captures from all relevant timeframes culminating in a successful trendline-based trade example. That topic went beyond the scope of last month’s posting, but as we promised then, this month’s article is going to do exactly that: Walk you through a detailed anatomy of a winning trade example which really pulls all the pieces of the puzzle together in terms of Top-Down Trendline Analysis.

[1] To find out more about the Trendline Mastery foundation course, please visit our public FAQ page via www.forexmentor.com/trendline.  And to find out more about the Trendline Mastery Trader’s Club, please visit www.forexmentor.com/trendline/club.php.

Picture of Person Looking Top-Down

Top-Down Analysis means starting from high up and looking downwards for lower-level detail once you have the lay of the land…

While it might seem very detail-heavy to pick apart every last aspect of such a trade example, if you take the time to study it intensively (maybe even replicating the annotations in your own charting platform to really make them your own), you will undoubtedly find that the concept we’re shooting for here becomes more deeply engrained.  And doing that, in turn, will give you a much better intuitive understanding of how to go about the task of finding your own trend trades in future, successfully deploying all of the tools and techniques we mention regularly here, and of course in our home study course and membership service under the Trendline Mastery umbrella, available exclusively from www.forexmentor.com.

As a matter of fact, if you want to test your trendline analysis skills before working your way through this article, it might be a really beneficial exercise to go to your multi-timeframe chart template for one specific pair at one specific point in time, and before you see what we had to say about it, figure out for yourself through application of your own knowledge of trendline analysis, why it is that we suggest that this one particular juncture represented a high-probability trade entry opportunity.

So let’s do that right now – let’s identify a specific pair, and a specific date and time. And if you want to test your skills, look at all of the Monthly, Weekly, Daily, 4hr, 60m, 15m and 5m charts for that pair as of that particular juncture, and see if you can identify the reasons why it made sense to look for a trade right at that moment (again, with recourse to Top-Down Trendline Analysis only, not indicator readings or other forms of Technical Analysis).

Once you’ve done that homework, you can come back to finish the rest of this article, and see how close you did or did not come to replicating the analysis we’ll be talking our way through for the duration.

So here it is: The case study example we’ll be looking at for this article is as follows:

Case Study Summary Statistics

Currency Pair: CAD/JPY
Trend-trade Bias: Bearish (Sell)
Date (of trade entry): Tuesday, January 5th, 2016
Time (of trade entry): 9:00am GMT
Entry Price: 85.55
Price for Initial Protective Stop: 85.80
Maximum Drawdown on Trade: 5 pips
Day Trade Exit Target: 84.74
Profit (excl spread): +81 pips
Reward/Risk performance: 5.4

Please note: The above noted trade summary statistics are not meant to imply that the trade in question was the only – or even necessarily the best – vantage point for a short trade on the CAD/JPY pair in early January. There were several other opportunities at different timestamps throughout January to trend-trade short (and later in the month, to trade long on a major reversal). So this example wasn’t the only one to consider, but we chose it because it does a particularly good job in demonstrating what can happen when all of the pieces of the Top-Down puzzle come together in the ideal fashion. Furthermore, we do not mean to imply that the only possible interpretation to come to is the one we offer in the following paragraphs; differences of opinion are always possible when comparing one trader or analyst’s work against another’s. That said, hopefully any variations between your work and ours are minor enough as to allow for us both to come to the same overall conclusion

And one last point before we dig into this trade. If you are a longer-term student of the markets, and have spent any amount of time on trading forums, blogs and social media feeds, you may have come across someone making the complaint about trading instructors resorting to the practice of “cherry picking”. If you’ve never heard that term before, let us define it for you. When it comes to trading instruction, “cherry picking” means choosing a chart example in after-the-fact fashion which specifically proves whatever point the instructor is trying to make.

Obviously, hindsight is 20/20, and at the same time – given the uncertainty of any outcome in real time – not an accurate representation as to what a trader has to deal with when making a trading decision. These are all fair and justified criticisms. In an ideal world, a trading instructor working hard on a detailed and elaborate presentation (usually with a deadline to meet!) would be able to walk through all aspects of a trade example live, and would be able to capture all that detail in one fell swoop. Unfortunately, though, that is not a realistic expectation. For one thing, a trade that takes eight or ten or more hours to run its course cannot be captured live in its entirety, because that would mean editing out the amount of time it takes for the trade to run its course. And if the trade example included only the entry and not the exit decisions, it would be incomplete.

Just as importantly, “cherry picked” examples can actually be a good thing, because they show you what the ideal is that we’re shooting for, as compared to some incomplete, half-baked example that fails one or more trade entry criteria, which is why the trade should not have been attempted anyway (and thus diminishes its usefulness as a template for the ideal trade). So, from the very outset we concede that – yes – this chart review we’re going to go over with you today represents a “cherry picked” example. But if you can remember exactly what this cherry picked example looks like in the back of your mind next time you go hunting for a high-probability trend-trade opportunity, you will have an easier time finding it in real-time, and knowing exactly what to do with it.

So, without any further ado, let’s get started. Our presentation format is going to involve briefly and simply analyzing each of the individual charts in Top-Down fashion – beginning with the Monthly and working our way down all the way to the 15m timeframe. On all of these charts, you will see a cross-hair coordinate comprised of a single dashed vertical line representing the time component (i.e. the live bar at the time the trade execution as available) overlapping a single dashed horizontal line representing the entry price on this trade as referenced in the summary statistics provided above. Together, these time and price coordinates show where we were on each individual timeframe when the drill-down to a setup and then a trade entry signal materialized on Tuesday, January 5th, 2016 at 9:00am GMT. All of the trendline annotations we reference here were specifically available before the trade setup materialized, so the ‘after-the-fact’ nature of our presentation changes nothing with regards to how viable or not the trade opportunity would have been in real-time.

MONTHLY CHART through to the month of JANUARY, 2016

In the Monthly chart capture below, the live bar is shown on the far right: the monthly bar for January, 2016 (overlapping the horizontal line at 85.55, which was the trade entry price). The idea here is to work backwards from the live edge of price action and observe any clear progression of Swing Points that can be gleaned. (Reminder: A Swing Point is typically a 5-bar pattern, with a SP High comprised of a middle rejection wick high preceded and followed by two lower highs on both sides; and a SP Low comprised of a middle rejection wick low preceded and followed by two higher lows on both sides. In a downtrend, to draw a bearish trendline as per this example, we want to look for descending SP Highs, not SP Lows).

If we see two or more SP Highs aligned in a down-sloping progression, we can connect them to yield a so-called “Tom DeMark style” Falling Resistance (aka supply) trendline. The junctures that stand out in that regard are labeled “1” and “2” on the chart capture below; the former being the SP High for the month of December, 2014 (price high of 106.51 on the ProRealTime hybrid feed); the latter being the SP High for the month of June, 2015 (price high of 101.15). The trendline that captures this progression of Swing Points is the solid black diagonal line to the right-hand side of the chart:

Chart Example #1: Monthly Chart
Monthly Chart

So there we have it: On the first chart we look at it in top-down fashion, we have a strong indication of a sustained downtrend because there is a resistance trendline intact and price is showing no signs of breaking up and through it (which, if it were to happen, would invalidate the trend reading). Now, that fact by itself means next to nothing in terms of the decision of whether to look for a trade or not. If we see price trending strongly in the opposite direction – up – on a plurality of lower timeframes, then we might be in the midst of either a sustained retracement, or possibly even the early stages of an outright trend reversal which has not yet resulted in a trendline break on the Monthly. In either case, trendline analysis aligned in opposite direction on “too many” lower timeframes at once might represent a dangerous scenario in which to enter a short trade keying only off the Monthly chart only, since the counter-trend move in question could trigger a stop of almost any size if it keeps on extending, and specifically against the directional bias of our trade. So, the Monthly chart trendline is interesting, but by itself is not a depiction of Top-Down analysis. For that, we need to replicate the trend bias on multiple timeframes.  So, on we go to the next lower timeframe, the Weekly chart…

WEEKLY CHART through to the week beginning JANUARY 4th, 2016

So we’ll just apply the same dead-simple analytical exercise on the Weekly chart working backwards from the live bar for the week beginning Monday, January 4th, 2016, as we just performed on the Monthly bar for January: Do we see a clear and sustained progression of Swing Points?

Now, before we proceed, let’s be very careful of one potential pitfall; that of forcing an analysis to satisfy some irrational bias or hunch we heard on a chat room or from a friend. We don’t specifically “want” to see a trendline here unless it fits and is real. Trying to prove a case by making bad facts fit a bad analysis is not the way to go. Instead, be completely honest with yourself and be constantly asking yourself the following questions:

  • Does the trendline I’m trying to draw conform to proper rules and guidelines for trendline annotation (e.g. as presented in the Trendline Mastery course)?
  • Do I see a clear and obvious progression of Swing Points to the right-hand side of the chart?
  • Do apparent retracements against the prevailing trend appear to have been slow-moving and possibly choppy (comprised of Doji bars and low ranging bars) whereas the legs up or down aligned with the prevailing trend look stronger, faster moving and comprised of a relatively larger number of wide ranging bars?

If the answers to any of those three questions is “no”, or if at the very least you feel any doubt or uncertainty whatsoever in your analysis, then you should not proceed. In such situations, simply focus your energy on some other pair that presents a clearer picture. (The twice weekly updated “Forecast Pack” PDF reports published at the Trendline Mastery Trader’s Club member’s site will save you much time and effort in that regard!).

In any event, getting back to the subject at hand here – the Weekly chart through to the open bar as of the week beginning January 4th, 2016 – we see three prominent SP Highs in descending order which allow us to draw bearish trendline on this timeframe, which obviously aligns with the bearish analysis we came up with on the preceding Monthly chart.


Chart Example #2: Weekly Chart
Weekly Chart

Juncture #1 is the SP High for the week of December 8th, 2015 (price high of 106.51).  From there, price put in a strong leg down (a so-called ‘Impulse Wave’, as distinct from a retracement) then retraced upwards culminating in a lower SP High for the week of June 15th, 2015 (labeled as juncture #2 in the screen capture below, with a price high of 101.15).  From there, another bearish Impulse Wave followed by another upside retracement, culminated in a third SP High, that for the week of November 30th, 2015 (labeled juncture #3 with a price high of 92.78). So we then draw not just one Falling Resistance Trendline from the first to second SP Highs, but also a second from the second to the third SP Highs specifically labeled.  The first trendline we can refer to as the ‘Primary’ resistance trendline, since it spans a longer period of time, while the second trendline we can refer to as the ‘Secondary’ on this timeframe, since it is of lesser duration than the first. That said, the trendline we should regard as being ‘active’ is the most recent one, i.e. the Secondary line.

The interesting thing about this Weekly chart review is that it quickly becomes apparent that the slope or angle of the second of the two trendlines shown is sharper than that of the first. We can infer from this so-called ‘slope change’ that the downtrend is actually accelerating by the time we reach the far-right hand side of the chart. And that is a good thing; it tells us that the market is moving downwards with greater speed than before, possibly with less push-back from potential support levels encountered along the way.

So far, we’ve looked at two charts – the Monthly and Weekly – and both are sporting a promising concurrence of bearish trendline analysis. While this is a good start, our ideal scenario is where we have agreement amongst all four of the upper timeframes – Monthly, Weekly, Daily and 4hr – and that means we have two more timeframes to consider before we can say we have a true top-down trend. The next chart in that sequence is the Daily…

DAILY CHART through to JANUARY 5th, 2016

If we trace backwards from the Daily bar for January 5th, 2016 on the far-right hand side of Chart Example #3 below, it almost looks as if the Falling Resistance Trendline shown was specifically drawn to connect to the high of the preceding daily session; but it was not.  In actual fact, that trendline pre-existed the January 4th high, drawn to connect Swing Point junctures #1 and #2 (the daily highs for December 3rd, 2015 at 92.78 and December 7th, 2015 at 92.22, respectively). So a more accurate assessment of juncture #3 on this chart is that it represented a test of the intact pre-existing bearish trendline shown, as resistance. And because that trendline withstood the test and price thereafter slumped downwards, we have yet further confirmation that the prevailing downtrend is still intact down to this third of four upper timeframes in sequence.

Chart Example #3: Daily Chart
Daily Chart

So far, we’re three-for-three with finding consistent bearish trend line analysis on these charts we’ve looked at, and if we can replicate it also on the 4hr timeframe, we’ve got ourselves a really strong case for a sell bias. (It bears mentioning that just because we have a trend-trade bias on the short side does not mean that it is impossible to buy, just that if you are going to do so, you need to keep firmly in mind that you are trading specifically counter-trend. This is both a riskier bias than trend trading, typically involves shorter time horizons on the trade, offer lower absolute profit potential and Reward/Risk potential, and mandates the use of purpose-built scalping strategies. If any of that feels less than comfortable for you, then simply bypass counter-trend scalping altogether, and look to trade with the trend only, in the path of least resistance and in the direction where you are more likely to experience big momentum bursts that can really benefit correctly executed open positions).

So, onwards now to the 4-hour chart…

4HR CHART through to 8:00am GMT, TUESDAY, JANUARY 5th, 2016

Working backwards from the far right-hand side of the chart, we see that by the time price comes down to the horizontal dashed line capturing the trade entry price of 85.55, it is already well in the process of breaking a low-level corrective support trendline (drawn from the SP Low for January 4th, 8:00am GMT at 85.18). One of the reasons why we could assume this demand trendline was counter-trend rather than trending was that the prevailing bearish bias on this timeframe was captured by the Falling Resistance Trendline connecting SP Highs 1, 2 and 3 labeled in this screen capture, and of course by the trendline analysis apparent on the next three higher timeframes.

Chart Example #4: 4hr Chart
4 Hour Chart

60m CHART through to 9:00am GMT, TUESDAY, JANUARY 5th, 2016

By now, you’re probably starting to sense the power and reliability of a trending market where the same bias is conveyed on all of the four upper timeframes at once. That doesn’t mean that other types of good trades can’t be found without this criterion being met, or that price might not take off like a rocket sometimes without it; just that when you do take the time and effort to find this kind of scenario unfolding, it makes the job of finding a trend trade opportunity easier, and it bolsters your confidence in the ensuing trade decision. And let’s face it, every time we can proceed with more confidence rather than less, at least one half of the usual definition of trading psychology – the ‘fear’ factor – manages to take care of itself.

In any event, the 60m chart capture shown below demonstrates two really useful aspects of Top-Down Trendline Analysis. The first – of interest to traders who might have a pre-existing fondness for Fibonacci tools and techniques – is that Fibonacci retracement drawings tend to work extremely well within the context of trendline based methods. In the chart extract below, we’re using a three-point labeling scheme, whereby the SP High labeled “A” is the start of the latest Impulse Wave on this timeframe (aligning, obviously, with the higher-level downtrend we already noted), the SP Low labeled “B” is the latest interim bottom from which a retracement got underway, and finally, the SP High labeled “C” is a corrective top forming below the last high. Of great interest is the fact that “C” topped out virtually spot-on a specific Fibonacci retracement level, the 50% marker against the preceding leg down (from 87.01 to 85.18). That close proximity prior to a turn suggests that the Fibo level in question was indeed real resistance, not a mere guess or coincidence.

Chart Example #5: 60m Chart
60m Chart

So the first point to be made here is that though you don’t specifically have to incorporate Fibonacci style retracements within Top-Down Trendline Analysis, the fact is you can if you want to, and these two methods tend to work extremely well together. In fact, with a little practice under your belt, you could easily come to the conclusion that Trendline + Fibonacci = A Real Winning Formula!

The second interesting aspect of the 60m screen capture shown here is that it is when we can find, firstly, an intact trendline on a lower timeframe moving specifically counter to a much stronger, multi-timeframe bias higher up where we have a potential setup to a strong selloff yet to come; and, secondly, where price breaks that counter-trend line on a close on the other side, we have a pretty good tip-off that exactly that scenario is unfolding. The circled portion on the bar second to the right hand edge in this screen capture highlights where the corrective support trend line in question is being broken, and the close of that particular bar confirms it. So, by the time we get to the bar on the very far right, we have a recent break of a corrective support trendline behind us. And that should position us for some good follow-through to the downside, whether in pursuit (conservatively) of the ADR Target Low for the day, or possibly some other Measured Move target enabling a longer-term trade (if it can be found).

(A minor note: One thing we did not show on this chart capture is that after the last trendline is broken, we should be looking to draw a new trendline in the opposite direction; in this case, a Falling Resistance Trendline anchored from the corrective top labeled Swing Point “C”).

LOWER-LEVEL TIMEFRAMES: EITHER THE ‘ALL CLEAR’, OR A SECONDARY ENTRY TRIGGER

The only timeframes left to account for a true Top-Down Analysis that we haven’t looked at yet are the 15m and 5m timeframes.  For this case study example, neither of those charts provides us a particular trade entry signal or confirmation as of the open for 9:00am GMT on Tuesday, January 5th, 2015. Typically, we might look for a low-level retracement appearing on either or both of those timeframes, ideally depicted the same way as the Downtrend Continuation pattern setup we just looked at on the 60m chart would (albeit to typically much smaller scale). In other words, price makes a SP Low on either or both of those timeframes, then makes a small upwards retracement that is not enough to break any of the resistance trendlines seen on the higher timeframes (which we can denote with a low-level support trendline), then later breaks the line on a close.

That latter event would constitute a potential secondary entry trigger, if we happened to need it due to having missed the trendline break we just saw on the 60m chart.  In this particular example, however, at the specific juncture in question, neither the 15m nor 5m chart fulfills that function, but rather another one which we should always keep in mind. We can call it the ‘All Clear’ function. What we mean by this is that if price just cleared a 60m counter-trend resistance trendline, but is showing no signs of rallying on either or both of the 15m and 5m charts at that point in time, then we can assume we have the ‘All Clear’ (i.e. permission to proceed) to execute on the higher-level 60m break entry trigger. This is a useful trade entry filter to keep in mind, as it is indeed sometimes the case that no sooner than price breaks a trendline on one timeframe that it is breaking in the opposite direction for a lower-level retracement on the next lower timeframe(s). When that happens, simply wait for a break in the trending direction once that lower-level retracement has run its course.

So the 15m chart capture below does not provide us a secondary trade entry trigger, but as of 9:00am GMT on January 5th, we have the ‘All Clear’ provided by way of a resistance trendline intact even all the way down to this timeframe as well. We won’t repeat the analysis for the 5m chart; suffice to say (as you can see for yourself if you look it up), it showed us the same thing.

Chart Example #6: 15m Chart
15-min Chart

WRAP-UP

In this case study example looking at the CAD/JPY pair as of January 5th, 2016, we’ve tried to demonstrate the power and effectiveness of Top-Down Trendline Analysis for the purposes of: 1) Finding the strongest possible trend reading – one which simultaneously shows the same bias on multiple timeframes (with our example here, not just the so-called ‘Quad Screen’ timeframes, but also the 60m and even 15m charts); 2) Allows us to anticipate so-called ‘Continuation Setups’ where price first retraces on a lower timeframe; and then: 3) Breaks in the trending direction by closing on the other side of the corrective trendline. There are additional tools and techniques of Top-Down Trendline Analysis that might have come in handy here as well (e.g. Measured Move price projections, secondary entry setups at later junctures during the week in question, etc), but we’ll leave it at that for now, focusing on the most salient aspects: trade bias, setup, and entry trigger.  Putting all the pieces together in this fashion allowed us to find a strong sell candidate.

The foregoing analysis might have seemed exhausting to go through, and we certainly put a lot of verbiage into explaining various aspects of it. But please don’t fear that this somehow conveys an onerous or difficult approach to trading; nothing could be further from the truth! In a tiny fraction of the amount of time it took me to write this article, I could have completed the Top-Down Analysis in real-time that allowed for the sell bias. If you just take the time and effort to practice drawing trend lines and then cobbling together these analyses across multiple timeframes, the process becomes fast, simple, intuitive (albeit rules based), easy to understand and implement, and possibly much more effective for you than working with indicators, or with other forms of chart analysis which are frequently far more complex.

Put simply: Take the time to learn and understand how to apply Top-Down Trendline Analysis, and you just might be amazed at how quickly it allows you to zero-in on high-probability trending Forex pairs (or any liquid financial market, for that matter).

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In conclusion, we’d like to thank you for joining us here today. We sincerely hope that this blog article has provided you some useful insights into the topic of trendline analysis for Forex trading. If we 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: info@forexmentor.com. Please also be sure to follow our Twitter feed (@fxmtrendline).

Good Trading!

About ForexMentor

Frank Paul

Frank Paul at Forexmentor.com

Frank Paul at Forexmentor.com

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.)

“…purchased at least two of your courses and I must say that I greatly appreciate your methodology and willingness to share with others. One of the things I appreciate most about you is that you are not like some of those money grabbers out there who is so quick to sell you a system for huge bucks. I believe you are a very genuine person who would want to see me or anybody succeed in their Forex Trading career. Thanks again, Omar.”

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