CONFIRMING AND DETECTING TREND CHANGES: THREE-LINE BREAK CHARTS

Three-line break charts are useful for detecting and confirming trend changes. Threeline
break charts are increasingly available to retail traders through their forex firms
and through charting companies. They are worth using because there is little ambiguity
whether a trend is in place and also at what point it would be considered reversed.
Therefore, three-line break charts provide the ability to confirm trend direction in any
time interval and project where the trend would be considered reversed! Three-line break
charts are excellent charting tools to help answer the question: In which direction should
a trade be taken, and where should I enter the trade?
Let’s explore this chart tool and how it shows trend strength, trend stability, and
trend direction. The chart looks like a candlestick chart, but it is not. Each block represents
the completion of a new high or new low. The chart therefore shows only consecutive
highs or consecutive lows. This provides a snapshot of the sentiment. What the
trader is looking for is the predominant direction of the sentiment, whether the sentiment
is weakening, and (most importantly) whether it has reversed.
In the example in Figure 10.4, there are 10 blocks (or lines) down and then a reversal.
At the point where the reversal block went past the previous three down blocks, we get
a reversal signal. The trader can look to buy at that point since the market showed the
ability to reverse the sentiment. This is why it is called three-line reversal. Similarly, move
to the right of the chart and we can see that after 17 consecutive new highs, there was
a reversal down. If the trader is looking to confirm a decision to buy or sell, then the
three-line break pattern is used to support that decision. If there is an intention to buy,
then the three-line break blocks should, at a minimum, show that the market is in a buy trend by showing that it is producing consecutive closes of newer highs. The timing of the
entry may be based on other setups, but it is even better if the entry to buy occurred on
the three-line break reversal from a previous series of down sequences. The decision to
sell a currency pair would be confirmed by having the three-line blocks showing a down
sequence, and preferably the entry would occur upon the reversal. The trader has the
challenge to select the right time frame for the three-line break charts. Using a day chart
converted to three-line break chart will show consecutive day closes of highs or lows.
This does not mean that there will not be intraday reversals of important magnitude. It
won’t show up. As the trader selects shorter time frames, such as the 4-hour, 30-minute,
and 5-minute three-line break charts, the trader will recognize the strength of the trend
sentiment from a multiple time perspective.
The first important use of three-line break charts is to decide to trade with the threeline
break direction. But it can be with the day, 4-hour, 30-minute, or 5-minute directions.
If they are all aligned, it is the best of all worlds. Using the 5-minute three-line break
charts provides a short time frame but still enables the trader to detect trend direction
and reversals that lead to magnitudes of 20 and more pip moves that can be captured.
Take a look at the U.S. dollar–Japanese yen (USDJPY) 30-minute three-line break
chart right before and after the February 27 sell-off that affected the world’s equity and
currency markets. We can see that by using three-line break charts, the trader would have
had a first reversal at 121.4 for a sell signal. Then the pair proceeded to close 16 new
30-minute lows consecutively before it reversed up briefly; a new reversal at 120.4 occurred,
followed by 18 new lows; and then it reversed back to 118.2. The dramatic fall of
the USDJPY is seen by the three-line charts as very strong, with long sequences of selling
creating new lows consistently (Figure 10.5). There were very few buying opportunities.
An alert trader would be to use the three-line chart to join the sentiment ride down, but
would know when to get out (when it reversed up) and when to get in again (when it reversed back down). One of the biggest mistakes traders make is to be caught on the
wrong side of the market. Three-line break charts reduce this kind of error by defining
the trend in an unambiguous way. Trading with the trend can be rephrased as trading
with the three-line break trend.
Using what you have just learned, take a look at a chart of the New Zealand dollar-
U.S. dollar (NZDUSD) (Figure 10.6). It is a day chart with a three-line break in it. We can
see this pair had very nice alternative sequences of up and down trends. The trader who wants to buy would see that the pair is in a downtrend and that the NZDUSD has just
reversed an uptrend. The trader would want to wait for a reversal again at point B.




By ABE COFNAS