Knowing more about trendline and trendline breakout is the key to successful and profitable trading. Trendline analysis is one of the most basic technical analysis techniques. Therefore, it is important to learn about it. Additionally, trendlines also offer the simplest but most powerful trading signals. This makes them even more important to learn about. Similarly, it is very easy to trade trendline breakouts when you know the basics.
Given the importance of the trendline breakouts, we decided to help you understand all about it. We are going to share with you a step-by-step guide to learning a simple but profitable strategy to trade trendline breakout. So, read carefully and understand it thoroughly. It is going to help you a lot in your trading journey.
Trendline breakout strategies
Trendline breakouts are simple but very profitable trading signals. Experienced traders use graphical price data and other metrics such as trading volume to find the best entry or exit points. These are actually major signal posts that enable traders to enter or exit trades at the best possible points.
If we look at trendline breakout strategies, we can see that these strategies are based on breakouts – when trend lines break. Thus, traders analyze the market direction and also predict the time period price momentum might last.
Trendline breakout strategies – made simple
Trendline analysis is one of the most basic technical analysis techniques. In this technique, you try to find out areas of support and resistance and their angle on the chart. Secondly, timeframes are also very important. The trendline is more important when it forms over a long timeframe. For example, a trendline forming over a period of a week or two is more valid as compared to a trendline forming within a few minutes. Why so? Because it forms over a longer period and requires a lot more volume.
Furthermore, if we look at ways to trade trendline breakout, there are a few strategies. The easiest and simplest strategy involves buying or selling security whenever the price breaks above or below a trendline. However, this is a risky one because you may encounter a false breakout. So, experienced traders don’t do it that way. Conversely, they wait for confirmation, and confirmation is provided by a candle closing above or below a trendline.
There are also some investors who are more risk-averse. They patiently wait for the price to return and retest the trendline. If it happens, it suggests that the breakout is strong enough and has plenty of momentum behind it. Finally, risk-averse investors move into positions. However, sometimes they also miss the breakout because prices don’t always retest the trendline.
Now, let’s move to our main topic – a step-by-step guide to learning a simple but profitable strategy to trade trendline breakout.
Step 1: Identify the trendline
As you know, you cannot identify a trendline breakout if you don’t know about the trendline and how to identify it. Basically, a trendline is a line that connects two or more highs or two or more lows. Thus, the line projects out into the future and helps us predict future prices. The following tips will help you draw a sound trendline.
- Connect swing lows to swing lows or swing highs to swing highs – it means you need to connect highs or lows formed by the price action on a price chart. However, it is important to keep in mind that there should not be a single candle breaking above or below that trendline.
- Connect more points – although connecting two highs or lows may form a trendline, connect more points. A trendline connecting more highs or lows is a solid one. Additionally, such a trendline is more important because a trendline never lasts forever. It will eventually break out. So, there is also an element of confirmation in a trendline connecting multiple points.
2. Step 2: Wait for confirmation
It is important to wait for confirmation when using the trendline breakout strategy. When price comes near a trendline, there are two possible outcomes. The price may bounce back or it may break above or below the trendline. Furthermore, if the price eventually breaks the trendline, it is important to wait for confirmation. This is because you may find yourself trapped by a false breakout. How to find a confirmation signal? Just wait and observe how the current candle closes.
Furthermore, if you want further confirmation, you may wait for the price to retrace back to support or resistance level and then continue back into the breakout direction. However, it is important to note that it doesn’t always happen. Price may not retrace and thus you may miss breakout.
3. Step 3: Set up the trade
As you know, you need to buy when there is a bullish trendline and vice versa. Let’s suppose that you are looking to trade a bearish trendline breakout. You can set up the trade by using the following easy steps;
- Place a sell order to sell just below the trendline.
- Set a stop-loss order several pips above the trendline.
- Attach a limit according to your risk/reward ratio (at least twice as large as your stop-loss)
It is crucial to set a tight stop-loss. It helps you avoid significant losses in case of a failed breakout. For example, if you are in an upward-trending market, set a stop-loss just below the trendline. Conversely, set stop-loss just above the trendline when you are in a downward trending market.
Why are trendline breakout strategies important?
Trendline breakout strategies are important because they are tested strategies, are easy to execute, and also offer good returns.
- Firstly, trendline analysis is one of the oldest and most trusted technical indicators. Thus, they have proved their importance over centuries.
- Secondly, they are easy to execute because of the binary nature of possible outcomes. That means the price may or may not break above the trendline. You see, there are only two outcomes – breakout or bounce back.
- Thirdly, trendline breakout strategies are useful in both trendings as well as range-bound markets.
- Fourthly, these strategies are important because they rely on trends. As trends are your friends and help you maximize your profits, trendline breakout strategies are always important.
- Fifthly, these strategies are suitable for all asset classes and also fit in well with other trading strategies.