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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. I show the steps that I used to backtest the strategy and let you know how you backtest your strategies.
You can also download a free 3 Line Break spreadsheet.
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
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.
How I backtested the strategy
The test was straightforward. It was intended to find out whether 3 line break charts can be a useful part of a trading strategy.
Time needed: 1 hour.
How to Test a 3 Line Break Chart Trading Strategy
- Decide How You Will Set Up the Backtest
For my test, I used a Tradinformed Backtest Model. This is a model template based in an Excel spreadsheet. You can find out more about how you can use these for your own backtesting at the bottom of this article
- Choose a Market and Timeframe
The market and timeframe are the most crucial decision you will make. Do not think that all markets and timeframes are equal! For this strategy to work, you need to find a market and timeframe that have good trends and also (ideally) have a low cost of trading.
I carried out my test on the EUR/USD forex pair on the 4-hour timeframe between December 2009 and June 2015.
- Set the Strategy Rules
My entry rules are simple enter a new trade on a new reversal line.
In my backtest I did not test the effect of stop-losses, trailing stops or profit targets. I also did not filter trade entries by time of day.
But all of these could and should be tested before trading live.
- Decide Whether to Use a Filter (or Filters)
I tested using a 200 period EMA as an optional filter. This gives me an understanding of the long-term market trend
When the filter was active I only traded long when the price was above the 200 EMA and only traded short below.
- Review the Strategy Results
Review your strategy results using the metrics that are most important. I always want to see low drawdown, high profit factor and high overall profitability. In a Tradinformed Backtest Model you can review many different built-in metrics.
The results of my strategy are shown below: Results
- Decide Whether to Re-Test, Optimize or Start Trading
Now is the time to make a decision – is this strategy worth pursuing? Do you think there is real potential?
This is not the time to be idealistic. You don’t want to waste your time on unprofitable strategies. Be as ruthless as you can to find reasons why you should not continue to trade this strategy.
|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|
Download a 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.
Get Extraordinary Trading Results
The power to backtest strategies will transform your trading:
- You can test new trading ideas as they occur to you.
- You can choose only the best and most profitable strategies.
- You can trade with confidence, knowing that your strategy has performed well.
The analysis on this page was carried out using a Tradinformed Backtest Model. The models are created in Excel and allow you to test different markets, try different indicators and entry conditions. To see the latest models check out the Tradinformed Shop.