How to select tramlines in a tricky market

Today I want to show how tramline selection can be tricky at certain times. To illustrate this point, I have selected the GBP/USD. This market is notorious for its many spiky and zig-zaggy moves – behaviour that often makes it very difficult to pinpoint accurate and best tramline placement.

Let’s start with the market background.

‘Cable’ – GBP/USD – has been rallying and has reached the giddy heights of $1.70. This has the media in a buzz. Here, the ‘reason’ for the recent rally has been the high growth of the UK economy (higher than any other European economy) and hints from the Bank of England that interest rates will be raised soon. It sounds so obvious, doesn’t it?

There are scare stories galore of how the rising value of the pound will destroy exports and suck in even more hot money to inflate the London house ‘bubble’. But with interest rates on the brink of rising like Lazarus, cable must be on the path to $1.80, surely?

Where is the market in historical terms?

For perspective, it is always a good policy to examine the long-range chart:

GBP/USD spread betting chart

So where is the market in historical terms? Far from being high, it has only reached the Fibonacci 50% retrace of the 2007–09 decline where it was last trading in 2009.

The form of the decline is an impulsive five-wave pattern with a very long and exceptionally strong third wave. The recovery off the fifth wave low has all the hallmarks of a relief rally. That observation tells me to expect a resumption of the bear market at some point. And the 50% level is a great place to start!

What does the short-term picture tell us?

Here is the daily chart of the most recent leg up from last year’s lows:

GBP/USD spread betting chart The upper tramline is a very solid line of resistance because it has four accurate touch points and several near-misses; none of which exceed the line in an overshoot or pigtail.

I have drawn in my centre tramline across the most recent lows and again, there are many accurate touch points. Confirming this line is solid support is the lovely prior pivot point (PPP).

That means that since last August, the market has been trading in the channel between these two tramlines. Any break out of this channel will very likely be violent.

Completing the tramline picture, I have drawn in my third lower tramline equidistant, and it very gratifyingly passes though the one major low made back in July. That will become a major target if the centre tramline can be broken.

This is a very clear-cut tramline placing and I had no great difficulty drawing the lines. There were no real alternatives that made sense. So far, so good.

What to look for when placing tramlines

I had very little difficulty placing tramlines in the daily chart, but it is a totally different matter when I turn to the hourly chart:

GBP/USD spread betting chart

When I look for tramlines, I always want to find a good PPP on at least one of the tramlines. Here, I started with the upper line and selected my PPP and then I drew my line across the three major June highs, making it a very satisfactory line of resistance.

Then, with my parallel line tool, I selected the PPPs in late May/early June and found that it ran across the major 18 June low. Also, in the last day or so, the market has just broken this centre tramline, made a kiss and is now peeling away in a scalded cat bounce.

My third tramline nicely passes across the major 11 June low, giving me confidence that these tramlines are of excellent quality. With the centre tramline break, I can set my first target at the lower tramline.

The key to making a great trade

But are these the only high-quality tramlines I can draw? Let me have another attempt:

GBP/USD spread betting chart

Here, I choose an earlier PPP in mid-May and also the 25 May point, and draw it across the major highs, making this a very solid line of resistance.

My centre tramline is a little more ‘iffy’, but it does have the major 18 May low as a touch point. The market has just broken below this line (as it has in option 1). My lowest tramline has one accurate touch point and an overshoot. My first target is on the lowest tramline.

Which is the best option to choose when trading?

Well, it really doesn’t matter very much because we have a very recent tramline break in both cases. The only real difference is the slightly different first targets.

But there was an earlier tramline set-up that gave the game away:

GBP/USD spread betting chart

I have drawn a higher-sloping tramline set off the most recent highs/lows and when the centre tramline was broken yesterday, that was a shorting signal. The later signals in options 1 and 2 came as confirmation. Note the very large negative momentum divergence going into Friday’s 1.7050 high – a sure give-away that buying was drying up.

The lesson: when you think you have a great tramline set-up, keep looking for other equally valid sets – they may hold the key for a great trade.