Welcome to our monthly blog article for November, 2016, sponsored by the Trend line Mastery Trader’s Club membership service, and related foundation course.
The Trend Line Retest & Break Pattern: An Overview
For this month’s installment, I’d like to introduce you to a trendline-related trading idea that could potentially come in really handy for all those of you who are fully committed to the “Top Down” approach to technical trading.
The idea I have in mind references not only the power of trend line annotations in establishing a trading bias and Support/Resistance measured on the diagonal – which serves to expand the depth of analysis as compared to approaches that focus only on horizontal levels – but also the benefits of looking at multiple timeframes simultaneously.
As tempting as it might seem to consider the possibility of doing everything off of a single timeframe, the fact is that in doing so, it is absolutely guaranteed that at some point, you will miss a technical event of importance on some other timeframe that cannot be seen on the one you are trying to focus all your attention on – and your trading results will reflect that fact. So, once again, our latest written commentary is going to provide yet another unambiguous case both for working with trend lines, and working your charts top-down.
Let me begin by first explaining and describing the idea briefly, then turning to a recent chart example that demonstrates it well.
As usual, what we’re going for here is a well-timed setup and relatively low-risk entry trigger into a trending market. But in this case, we’re not going to rely on indicator readings of any kind, and instead put the onus squarely on two aspects of trendline analysis:
- Firstly, the kind of diagonal support (in an uptrend) or diagonal resistance (in a downtrend) that can indicate where a corrective move is possibly finished, i.e. on a retest of that already established trend line.
- Secondly, the kinds of confirmations trendline analysis can provide in terms of corrective moves in progress, and breakouts into the direction of the prevailing top-down trend, once that corrective trend line is broken on a close.
While most technical traders use the term pattern analysis to refer to something happening on one specific timeframe only, the concept I’m describing to you here is slightly more nuanced in that it happens across at least two timeframes. That might seem like a less than intuitive expression of the concept of “pattern analysis”, and yet, the parameters are formulaic and repetitive in the same way that more generic patterns are, like 123 Top Reversals, Wedges, Divergences, and so on.
So, what we’re talking about here is a two-chart recurring Forex pattern, and so why not give it a name? For that purpose, I would propose the following moniker: Trend Line Retest & Break (TLRB) pattern. Then again, don’t get me wrong – you can call it whatever you want. It’s not the name that matters (or any pretences to discovering anything that one could claim special authorship to), but rather the kind of opportunity it presents in terms of entering a trend trade smartly and with limited risk.
How we pull these concepts together into a singular trade setup is by finding the first bullet item cited above on a higher timeframe, followed by the second item on the next lower timeframe; for example, a trendline retest (say, a touch on a 60m Demand trendline), followed by an upside break of the corrective Supply trend line that might have presented itself on the next lower timeframe (the 15m chart) while price was pulling back on the 60m chart for its retest.
So, in this descriptive example, you would see price having risen well above a pre-existing Demand TL (validated by Top-Down TL Analysis incorporating the higher timeframes), then falling back towards it, and after price reverses from a successful retest back up again, from as close as possible to the price level which represents an intersection point with that 60m Demand TL, a drill-down to the 15m chart shows an upside break of a smaller scale Supply trend line that was evident before price touched the 60m Demand TL.
Specifying the Rules of Engagement for a Trend Line Retest & Break Pattern
If the descriptive example is hard to visualize or understand, maybe we can begin here by laying out some simple “Rules of Engagement” that tell you how to go about the process of finding a TLRB pattern setup:
- As usual, begin by conducting a Top-Down Analysis (starting on the Monthly chart and then working your way downwards from there, through the Weekly, Daily, 4hr and 60m) to determine that a specific pair is showing the same kind of clear, multi-timeframe trend bias as is reflected in all of the content updates published to the Trendline Mastery Trader’s Club site (including or Forecast Pack PDF reports, Trade Recap videos, Midweek Recap videos, and Hot Picks videos).
- Next, look for any instance where price has achieved a significant gap to the intraday trend line, defined as that in force on the 60m chart which aligns with the top-down reading described above. By the term “gap”, I mean price has gone well above a Demand TL in the uptrend, or well below a Supply TL in the downtrend. Once a Swing Point pattern can be confirmed (a SP High for the bullish gap above a Demand TL, or a SP Low for the bearish gap below a Supply TL), then one can anticipate a retracement that might allow price to pull back to a retest of the intraday TL apparent on the 60m chart.
- If the charting platform you work with includes a chart alarm tool that allows you to point and click on any technical element on your chart, set it at a trigger point about 5 pips ahead of the intersection point of the 60m TL (5 pips above the intersection point of a Demand TL, 5 pips below the intersection point of a Supply TL). Once the alarm triggers, you are alerted to the fact that the trendline retest of interest may be imminent.
- Be sure to confirm that the pullback being watched does not have the effect of actually breaking the intraday trend line, a reversal that would be triggered most directly by a 60m close on the other side.
- Assuming that price shows signs of hitting the 60m trend line but without breaking through it on a close, drill down to the next lower timeframe – the 15m chart – and look for a corrective trend line that denotes the pullback price made on the 60m chart to enable its trendline retest:a) If the trend is up and thus the intraday (i.e. 60m) trend line in force is a Demand TL, then look for a corrective Supply trendline outlining the retracement on the 15m chart.
b) If the trend is down and thus the intraday (i.e. 60m) trend line in force is a Supply TL, then look for a corrective Demand trendline outlining the retracement on the 15m chart.
- Look for a break of the corrective 15m trendline into the directional bias conveyed by the 60m trendline still in force. Again, if the charting platform you work with provides a chart alarm tool, set it for a real-time break of the 15m line.
- On the close on the other side of the corrective trendline apparent on the 15m chart (above a corrective Supply TL, below a corrective Demand TL), a potential entry trigger is indicated. If all other technical elements are deemed acceptable and there are no significant extraneous elements to consider (overhanging S/R barriers on higher timeframes and/or potentially imminent Market Moving news events), then, at your sole discretion, you may consider entering the trade in the direction of the top-down trend.
- Once in the trade, set an Initial Protective Stop at 5 pips beyond the most recent Swing Point prior to the 15m TL break entry trigger, to a maximum of not more than 20 pips. To achieve a minimum acceptable Reward/Risk performance of 2:1, therefore, a Limit Exit can then be attached to the order, at an exit price of about 30-40 pips from the effective entry price on the order. Of course, if a longer term horizon is anticipated, then this 2:1 objective represents a minimum acceptable benchmark only.
A Mini-Case Study Example of a Winning TLRB Pattern Setup
As the saying goes, “A picture tells a thousand words”.
For technical-minded Forex traders, that saying probably means that actual chart examples go a lot further in explaining a concept than a simple verbal description. So let’s see now if we can’t achieve a full visualization of the TLRB Pattern described in the preceding paragraphs, with recourse to a specific pair at a specific time on a specific day.
The chart illustration I’d like to use for this purpose if the NZD/JPY pair with a long bias, about 90 minutes ahead of the New York Session open, on Monday, November 21st, 2016.
With the chart captures marked up with appropriate annotations that were in force prior to the pattern setup and entry trigger in question, we can go through the usual list of timeframes with an analytical focus on identifying the prevailing trend across the Monthly, Weekly, Daily and 4hr charts; then finding the TLRB pattern setup between the 60m and 15m charts.
So, here goes, a chart-by-chart analysis showing how we came to a valid TLRB pattern for the timeframe of interest. (Please note that the dashed vertical line shown on each chart timeframe provides a “You Are Here” point of reference in relation to the trade entry in question).
As we begin our Top-Down review, the Monthly chart shows us that the new monthly bar (for November) not only opened above the prior Supply TL dating back to the high of April, 2015 (denoted by the diagonal dashed line shown), but also made a rejection wick low that represented a retest of a relatively recent Demand TL, dating back to the low for June, 2016 and connecting to the low for October. So, as price started advancing above the November Open price of 75.00 even, a green bar painting in conformed to the expectation of a further uptrend. So the Monthly chart has a bullish bias ahead of the Daily session for Monday, November 21st.
Drilling down from the Monthly to the Weekly, we can see a fairly similar technical situation, although drawn to different coordinates: Firstly, an upside break of a prior Supply trend line (on the bullish close for the week of October 31st, against the dashed-format Supply line drawn from the SP High for the week of June 20th; and secondly, a relatively recent Demand trend line having already formed, connecting the two lows denoted by the green arrows shown on the chart, for the weeks of October 10th and November 7th. Though the RSI indicator was still below the 50 line at the time on the Monthly chart, on the Weekly and lower timeframes, we see a clear enough concurrence of bullish readings into Monday, Nov. 21st. So, the Weekly chart agrees with the Monthly, and both are conveying a bullish bias.
Save for a highly unusual long rejection wick (or “tail” or “shadow”) that reflected little more than short-lived “noise” resulting from the US election results on Wednesday, November 21st, an otherwise robust Demand TL extends rightwards from the SP Low for Tuesday, November 11th. Following a bullish crossover confirmed on the Daily close for Monday, October 17th, the RSI indicator remained above the midline value of 50, thus further corroborating the bullish trend bias otherwise evident. Finally, it is worth noting that the continuing updraft beyond the close for Monday, November 14th nicely corroborated the implications of the Bullish Engulfing Pattern that materialized on that particular Daily bar. At this point, we have three-for-three among the upper timeframes looked at thus far, all conveying an uptrend in force.
Prior to the open of the 4hr bar for 12:00pm GMT on Monday, November 21st, we can see a Demand TL in force on this timeframe as well; in this case extending from the SP Low for 11/14/0:00am GMT and connecting to the SP Low for 11/20/20:00 GMT (both connection points denoted by the green arrows shown on the screen capture above). Following a bullish crossover confirmed on the close for 11/14/8:00an GMT, the RSI indicator likewise generated a bullish reading without interruption up to the session open for Monday, November 21st. With this timeframe expressing bullish agreement, we now have a so-called Quad Screen reading, whereby TL Analysis is in agreement across all four upper timeframes. That’s a generally strong and reliable trend bias.
Now that we have our top-down uptrend clearly in view on the four upper timeframes, we can drill down to the 60m chart to see not only if the intraday trend reading is in agreement (on this chart, drawn from an initial SP Low for 11/17/19:00 GMT, connecting to the higher SP Low for 11/20/21:00 GMT), but whether a pullback from above it may be on the horizon. From there, a subsequent TL Retest could be expected to mark the end of the pullback. Because such an event would, in turn, convey support in the uptrend, a potentially explosive rally is thereafter always a possibility. Before we get there, a SP High from a measurable gap above the Demand TL in question should be identified, and in our example, we have one: for 11/21/7:00am GMT (conveyed by the red arrow in this capture). It’s good practice to note the price level that represents the intersection point with the trendline. Of course, this will change with each passing bar, reflecting the slope of the TL in question. As price drifts lower and lower towards the TL from above and reduces the measurable gap to the intersection point, we can increasingly anticipate where a reversal might occur. As it turned out on this example, the low for 11/21/11:00am GMT @ 77.68 came to within just one pip of the TL intersection point @ 77.67. The fact that it did not touch exactly on the trend line is not significant, because it is at a different price – following a TL break event on the 15m chart next – where the actual entry trigger is going to be looked for.
As we drill down to the 15m chart finally, we can see a corrective Supply trend line in progress from the starting point on the SP High for 11/21/7:30am GMT, to the lower connection point for 11/21/8:45am GMT. This trend line seems to outline the downside retracement that unfolded as price drifted back to the 60m Demand TL from a gap above. So, what we’re looking for here is a close above the Supply trend line to indicate two things simultaneously: 1) That the retracement is probably done; and 2) That the kind of “momentum push” move aligned with the prevailing trend that is expected following completion of a retracement is free to get underway anytime thereafter. In this case, the bullish TL break is confirmed on the close of the small Doji candle for 11/21/11:15am GMT. Though price subsequently and briefly stabbed downwards again from the entry price of 77.76, resulting in a maximum drawdown of 8 pips, it did not go any lower than the latest SP Low occurring before the TL break (denoted with the higher horizontal line segment drawn), let alone the Initial Protective Stop placed 5 pips below that level (denoted with the lower horizontal line segment drawn).
The follow-through that resulted from this near-perfect multi-timeframe confluence of a Trendline Retest on the 60m chart, followed by a bullish break of a corrective Supply Trendline on the 15m chart, was strong and swift, allowing for a profitable conclusion for any exit target pursued for the balance of that particular daily trading session – and beyond.
And that right there is the essence of a Trendline Retest & Break pattern setup for a multi-timeframe trend trade, resulting in an entry trigger that nicely conveys the essence of drilling down from one timeframe to the next in a trending market. Like any type of Forex pattern analysis, if you take the time to learn the pattern, and its Rules of Engagement, you can quickly train your eye to look for these patterns as part of your regular trade opportunity identification work. It’s all about buying the dips in the uptrend and selling the rallies in the downtrend, and the pattern-based method for doing that we have tried to demonstrate here certainly has those twin objectives in mind.
I hope you’ve enjoyed this trading “thought piece”. If you have any questions or comments on this topic, please feel free to direct them to me via email at firstname.lastname@example.org.
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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