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“A more subtle form of point and figure charts”
3 Line Break Charts are a fascinating type of charting system that originated in Japan. They are particularly useful for identifying the current trend and also trend reversals.
In this article, I explain what 3 line break charts are, give ideas for trading them and show the backtested results of a profitable trading strategy.
What Are 3 Line Break Charts?
The following chart shows the Dow Jones on the daily timeframe using 3 line break charts.
A clue to understanding these charts is in the name; they are a type of breakout chart. They are distinctive because they only show significant price moves. Significant price moves occur when the closing price is higher or lower than the preceding bars.
3 line break charts are based solely on the closing price and do not display any intraday movements.
This is based on the idea that the closing price is the most important price of the day. In this system, each bar is referred to as a line.
If you look closely at the previous chart, you can see that each line follows on directly from the previous line.
A short reversal can only occur when the market has closed below the low of the previous 3 lines. A long reversal can only occur when the market has closed above the high of the previous 3 lines. In the example below a short reversal line breaks below the preceding 3 lines.
A market is trending when there have been 3 consecutive lines in the same direction.
Why use 3 Line Break Charts?
If we compare the previous Dow Jones 3 line break chart with the standard candlestick chart it looks entirely different.
3 line breaks are great at defining the current market trend. A new line is always significant because we have a new high or low. This means that the chart is less cluttered. There is more information on the candlestick chart, but this can sometimes be distracting.
Trading with 3 Line Break Charts
The simplest way to trade using 3 line break charts, is to wait until the market has made at least 3 lines in the same direction. Then wait until a reversal line has formed and enter in the direction of the reversal. This is the start of a new potential trend and we can get in nice and early.
An alternative approach is to watch for reversal lines and then enter after the market has made at least 3 consecutive lines following a reversal.
It is easy to combine 3 line break charts with other technical indicators. For example, a moving average can be used to define the trend. Then a 3 line break can be used to enter in the direction of the trend.
Countertrend traders can combine 3 line break charts with momentum indicators to identify good reversal opportunities. For example, the stochastic oscillator can be used to identify overbought and oversold areas.
Another common way to use 3 line break charts is to combine them with Japanese candlestick patterns. Reversal candles and patterns such as dojis, bullish engulfing patterns and tweezer bottoms. The 3 line break charts can be used to identify the dominant trend and then the candlesticks are used to time trade entries.
A Profitable 3 Line Break Trading Strategy
How I backtested the strategy
I was interested in testing how profitable a simple 3 line break chart strategy was on historical price data. So I set up a backtest using a Tradinformed Excel spreadsheet. These spreadsheets are great for anyone with some basic Excel skills to set up and test their trading strategies. You can view the latest models in the Tradinformed Shop.
The test was straightforward. It was intended to find out whether 3 line break charts can be a useful part of a trading strategy.
The test was carried out on the EUR/USD forex pair on the 4-hour timeframe between December 2009 and June 2015.
- Enter a trade on a new reversal line.
- Test the strategy using an optional 200 period EMA as a filter. Only trade long when the price is above the 200 EMA and only trade short below.
In this backtest I have not tested the effect of stop-losses, trailing stops or profit targets. I have also not filtered trade entries by time of day. The results are shown in pips.
|Metric||No EMA||200 EMA|
|Gross Winning Trades||20952||10379|
|Gross Losing Trades||-17179.9||-7491.7|
|Net Long Profit||228||1199|
|Net Short Profit||3545||1688|
|Largest Winning Trade||862||583|
|Largest Losing Trade||-257||-230|
The results show that 3 line break charts perform nicely. The strategy is profitable even in this very simple form. Using the 200 EMA increases the percentage of winning trades and improves the profitability.
Download the 3 Line Break Spreadsheet for Free
If you are interested in using Excel for 3 line break charts you can download a free Excel spreadsheet containing 3 line break charts just by signing up to the Tradinformed mailing list.
For more information about using 3 line break spreadsheets, I recommend checking out Steve Nison’s excellent book – Beyond Candlesticks.
Steve Nison introduced and popularised candlestick charting into the west. The book contains a huge amount of information about trading using candlesticks as well as 3 line break charts, Renko charts and Kagi charts. Steve Nison’s more recent book, Japanese Candlestick Charting Techniques, Second Edition is also worth having a look at.