Trendline trading: drawing valid lines and trading the third touch

How to draw a trendline that means something

An uptrend is a series of higher highs and higher lows. A trendline joins those higher lows with one straight line, so that it slopes up beneath price. A downtrend line joins the lower highs and slopes down above price. The line is a visual statement of the trend's pace: how much higher each pullback has been finding buyers.

The rules for drawing one are short, and following them strictly matters more than any entry technique:

1. Use clear swing points. A swing low is a low with higher lows on both sides of it, visible at a glance. Do not connect random dips inside a move.
2. Start from a significant low. In an uptrend, the first point is usually the low the trend began from or the first clear higher low after it.
3. Choose wicks or bodies and stick to it. Drawing through wick lows is the most common convention. Some traders use candle bodies because wicks can be noisy. Mixing the two, picking whichever fits best each time, is how lines get fitted to hindsight.
4. Do not cut through price. A valid uptrend line has no candle closing below it between the points it connects. A wick slightly through is acceptable; closes are not.
5. Check the angle. A line much steeper than the trend's normal pace is describing a burst, not a trend, and will break soon. A very shallow line is barely a trend at all.

Two points are enough to draw a line, but any two points can be joined. The line becomes meaningful when price comes back and reacts at it a third time, and the more times it has held, the more traders are watching it. The academy lesson on trendlines and market structure has worked examples of valid and invalid lines.

The setup: the third touch

The core trendline strategy trades the bounce off the line in the trend's direction. It has three parts.

1. A valid line

Draw the line through two clear swing lows on the 4-hour or daily chart, following the rules above, and extend it to the right. Confirm the bigger picture agrees: an uptrend line on the 4-hour chart is stronger when the daily chart is also making higher highs and higher lows.

2. Price returns to the line

Wait for a pullback that comes back to the extended line. The touch does not need to be exact; within a few pips on a major pair, or a dollar or two on gold, counts. A touch that also lands on a horizontal level, such as an old swing high now acting as support, is a stronger setup.

3. The trigger

Enter when a candle closes back up and away from the line: a bullish engulfing candle, a candle with a long lower wick, or simply a strong close in the top part of its range. Buying the touch itself with a limit order gets a better price but takes every trade where price slices straight through the line.

In the chart above, the line joins two higher lows. The third touch near 149.56 holds, a bullish candle closes, and the long is taken with the stop below the touch low and a target at twice the risk.

Stops, targets and the break-and-retest

Put the stop below the low of the touch candle, on the far side of the line, plus a buffer for the spread. Because the line rises over time, a stop placed at a fixed price falls further below the line each bar; that is acceptable for a short trade, and it keeps the rule simple. Size the position from the stop distance with the position size calculator.

The first target is the previous swing high, the top of the last leg, or twice the risk if that is nearer. A trend that stays on its line will often carry on to a new high, so many traders take half at the first target and trail the rest below each new swing low, or exit on a close below the trendline itself.

The break-and-retest variation

When a trendline finally breaks, the line sometimes changes roles. Price closes clearly below an old uptrend line, rallies back up to the underside of it, and turns down again. Short traders use that retest as an entry, with the stop above the retest high. It is a trend-reversal trade with lower odds of a long run than a with-trend bounce, and it needs its own testing. The more conservative course is to treat the break simply as the end of the long setups on that line.

When trendlines fail

Every trendline breaks in the end, because every trend ends. The strategy loses money on the touch that turns out to be the last one: price comes back to the line, the trigger candle closes, the trade goes on, and then the trend gives way and the line breaks.

You cannot avoid that loss, only keep it small and stop trading the line afterwards. Some warning signs help:

• Weak bounces. Each push away from the line is smaller than the last, and the highs stop rising. The trend is losing pace even while the line holds.
• Many touches. A line touched five or six times has held a long time, which can mean the trend is mature. It is also a line every trader can see, so the stops clustered beneath it make a tempting target.
• A steep line. A line drawn through a fast move breaks sooner than one that matches the trend's usual pace.

The worst habit in trendline trading is redrawing. After a break, it is tempting to move the line to a shallower angle so that it fits again, and keep buying. That is no longer a trendline; it is a line fitted to justify a position. A useful rule: once a candle closes decisively through the line, the line is retired. If the trend is still alive, a new line through new swing lows will show it.

Trendlines are also subjective. Two traders can draw slightly different lines on the same chart and both follow the rules. That is a reason to treat the line as a zone a few pips wide and to look for agreement with horizontal support and resistance, not a reason to give up on them.

How to test a trendline strategy

Testing trendlines honestly is harder than testing an indicator, because you can always find a line that fits after the fact. The way round that is to draw only with information you would have had at the time.

1. On one market's 4-hour chart, hide everything to the right of the point you are studying. Draw the line only after the second swing low is confirmed, following your written drawing rules.
2. Step forward candle by candle. Record each third (and later) touch that meets the trigger rule, with its entry, stop and exit.
3. When the line breaks, retire it, and record any touches you would have been tempted to trade on a redrawn line separately.
4. Count the spread on every trade and gather at least fifty trades across a couple of markets.

Compare touches that coincided with a horizontal level with those that did not, and touches on lines of different steepness. Look at the average win against the average loss and the longest losing streak, and run that streak through the drawdown calculator before settling on a risk per trade.