The concept of tramlines, which I developed, is at the heart of my trading method.
On Monday, I showed how to use them to calculate accurate price targets in the euro/US dollar market.
Today, I want to do the same thing with a different currency pair: the pound/US dollar (GBP/USD from here on).
Tramlines are a purely visual construct – no fancy algorithms, no complex software or even sophisticated charting packages are required.
In fact, the tramline method is ridiculously simple to grasp and apply. All you need is an ability to draw straight lines.
In fact, you can go back to decades old historic charts and find great examples of major highs/lows lying on a straight line. Tramlines are a phenomenon of nature.
The tramlines can stretch for weeks or months between ‘touch points’ and in some cases, years. I am constantly amazed at how accurately it is possible to fit a straight line connecting multiple touch points over long time spans.
Let me illustrate with the long-term daily GBP/USD chart:
I can draw a magnificent trendline joining the major highs all the way down. I have labelled five accurate touch points to this line with red arrows stretching over seven months.
The end of a great trendline
On 6 February, the market made its last accurate bounce off the line (marked with purple arrow), proving the line remained a line of resistance (in other words, it repels the market). And that is the way I look at these trendlines – they resist market attempts to move through them.
And for a trader they are like gold dust, offering low-risk trades with the main trend. Anywhere along the line, a trader could place short trades with confidence and with protective stops just above the line.
But there was one other task I needed to do here. To validate a trendline as a tramline, I needed to see if I could find a parallel line which encompassed the action on the way down.
Here is my best fit:
The lower line has a very good prior pivot point (marked with the red PPP, a prior pivot point is a point where the market touches the tramline prior to it forming the trading channel). The lower line also has two very accurate touch points. This is a textbook tramline pair.
So now I have a very reliable tramline pair where all action took place between the two tramlines in what we call the trading channel. Isn’t that pretty?
Also, at the low, there is a very large positive-momentum divergence, which usually signals that a change of trend is coming. And that signal proved very accurate when the market moved up out of the channel earlier this month.
Time to examine the hourly chart:
I have a good tramline pair and the market is working towards the upper tramline as I write.
All in all, the odds are that the rally should run out of steam.
But with the US Fed head, Janet Yellen, giving a talk yesterday and today, the market is very interested in what she has to say about US interest rates.
As I mentioned in a previous post, the Treasury market has already given a clue that rates are on the increase – will the Fed follow?