Naturally, many traders will ask: “What is considered a valid penetration of a trendline?”
Well, there are different ways to determine that.
For starters, 2 consecutive lower closes below the uptrend line will signal a reversal to the downside.
Similarly, during a downtrend, 2 consecutive higher closes will signal a reversal to the upside.
Before we move any further let me clarify that to qualify the 2 closes the corresponding candlestick bodies should be of an average at least size to convince that the market is determined to move the prices in the corresponding direction.
Another way to determine a valid breach of a trendline is the 3% rule. To be more precise, a violation of 1-3% is required before calling it a valid penetration. The 3% rule may apply to higher timeframes, where the 1% violation may be more appropriate for lower timeframes.
In the following example of Gold, I am sure that you will agree with me that a 1 or 2% filter would suffice compared to 3%.
Now, Gold on the Weekly timeframe, a 3% filter would be more appropriate.
The last filter to mention is a Friday close below the uptrend line or above the downtrend line.
The Friday filter is important as traders who are committed to keeping their position open during the weekend where anything is possible to happen reveals their belief and confidence in the underlying financial instrument and its new direction.
Stay tuned for more!
See you in a while.