One of the most common methods used to define the long-term trend in the movement of exchange rates is the so-called the fan principle.
Oftentimes, after a break of trend, it follows a correction in the opposite direction, then, again it reaches the area of the original trend line, which in the case of an uptrend support, after the break, it is already resistance area.
It follows a draw of the second trend line. After a certain period, the second trend is broken and it follows analogous reaction, similar to that one after the break of the initial trend – a new reaching of area of resistance and reverse of the movement. Now we can draw third trend line, again in the original direction.
A break of the third trend is a strong signal for reverse of the direction of the quotations. This is the most important application of the fan principle – a break of the third trend gives a signal for a reversal of long-term trend.
A very important characteristic in this condition of the market is the extremely violent reaction of the quotes after a break of the third trend. This creates a good basis for the aggressive traders who, for a short period of time, manage to gain considerable profits.
Not only the tertiary trend gives a signal for the formation of new long-term trend, but also it can be used as a first area of resistance / support in attempt to return the quotations to the already broken trend.
In this case, after the initial impulse and extract of profits, traders use the reaching of the quotations of this area, for new entry in the positions or to increase the already formed ones.
After defining a new long-term trend, the broken primary and secondary trend line can be used as an indicator of the short-term adjustments. I.e., if we have a signal for a new formed long downtrend, the broken lines can be used, carried at the same time, and for base points are used the new formed lows.
This will give us an idea of the speed of the short-term growing correction. On the other hand, the break of these new lines, parallel to the broken trends, will be a confirmation signal to expect the formation of new lows and analogically, of proper area for taking new short positions.
Here is a short definition for the fan principle – formation of the primary term trend, break at point 1. Reaching the bottom and its using to form a second trend. Again continuing of the original movement and reaching a resistance area, formed by the initial trend. Break of the second trend and forming the third line – point 2. Breaking of the third trend and receiving a signal for a long-term change of the direction of the currency pair – point 3.