Simple trend line retracement strategy

Jan 04, 10:43 am
December 30th

There are many different trading strategies using trend lines and retracements. Most of them seem to be either discretionary or require many different variables making the trading strategy one that can post different results depending on how each trader views the prescribed trading methods.

In this trading strategy, we make use of trend lines and retracements but the rules are near mechanical which makes it constant across the instruments.

As the name suggests, the simple trend line retracement strategy makes use of only the trend line and the Fibonacci tool to measure the 50% retracement level. This is a short term strategy that is confined to the daily charts only, making this a system that can be easy to trade even among part time traders.

In the trend line retracement strategy we make use of the immediate trend and look for potential counter trend moves, or retracements. Some might consider this to be risky, but with good money management the trade’s objectives are quickly realized.

Trading rules – Trend line retracement strategy

The trading rules as very simple. Pull up the daily chart and switch to the bar charts. Make sure that the bullish and bearish bars are colored so you can easily determine if the bars were bullish or bearish.

For long positions, look for price action where the downtrend is overwhelming. There should be at least a minimum of 5 bars in the leg but at the same time ensure that you do not go beyond 12 or 15 bars. Connect the trend line to two consecutive highs in the downtrend, as shown in the chart below. The trend line should be positioned in such a way that the breakout from the trend is bullish.

Plotting the trend line for potential long position
Plotting the trend line for potential long position

Once you plot the trend line, using the Fibonacci tool, measure the high and the low of the complete leg and mark the 50% retracement level. At the same time, also mark the second lower high with a horizontal line.

Trend line entry and target levels
Trend line entry and target levels

In the above chart we have plotted two horizontal lines; one marking the 50% retracement level of the down leg, and the second horizontal line marking the lower high on the trend line. The next step is to wait for a daily bar to close above the lower high and then place a pending long order, targeting the 50% level. For stops, you can use either the low of the down leg or place the stops a few pips below the low of the second lower high bar that is used. A second position is opened at market at the start of the new daily bar but having the same stop loss and take profit levels.

The above chart shows that after the close above the breakout high and the second lower high, price eventually rallied towards the 50% retracement level, which is the take profit level.

In the next example, we have a short position set up.

Trend line retracement strategy short position set up
Trend line retracement strategy short position set up

The first thing to pay attention to here is the way the trend line is plotted. The specific lows have been selected such as the breakout of the trend line occurred with a bearish bar. This is extremely crucial and important to the success of this strategy.

After price breaks out from the trend line a short position is taken at market after price closed below the entry with the target set to 50% of the retracement in the previous up leg.

Tips that can improve the trend line retracement strategy

  • Do not expect too many signals using this method. However, you can anticipate a potential trading set up when you notice price moving strongly in one direction over the course of a week or a few days. You might not need to watch the charts every day but simply keep an eye out for mention of any currency pairs that seem to exhibit strong price action in a few days time
  • The entry level should always be higher than the 50% retracement level for a short position and in a long set up, the entry level should always be below the 50% retracement level
  • When you set up a pending order, if the trade is not triggered within two days, delete the pending order and move the first market order to break even
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John has over 8 years of experience specializing in the currency markets, tracking the macroeconomic and geopolitical developments shaping the financial markets. John applies a mix of fundamental and technical analysis and has a special interest in inter-market analysis and global politics.

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