Trendlines Trading – Video Tutorial

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Thomas DeMark trendlines tutorial – Effective technique for short-sell targets

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Hi guys a quick tutorial here on the Tom DeMark trend lines strategy.

Opposed to classic technical analysis, this technique is to be used alone, and not in combination with other indicators. It’s important to note that the way of drawing trendlines (according to Tom DeMark) should be from right to left and not from left to right like in traditional technical analysis & only using the two most recent touches instead of ‘the more touches the better’ or ‘the older in time the touches the better’ like in classic analysis. Also see how the stop loss is set using a different rule than the one used on classic trading.

There is a lot of math behind this technique but I’m not going into the details as for why the strategy works, I only show how to use it. I think people are interested in results, not details & I don’t want to make my free videos 2 hours long. If you’re interested to know more about it you can research Tom DeMark trend lines on google ;)

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How to Add Trendlines to Your Chart

Video Transcript:

Hello traders, welcome to the thinkorswim tutorial and the third module, charting. In this lesson I’m going to talk about drawings on your charts. And the reason why this is important is because drawings can be quite difficult for new users on the thinkorswim platform. You already know that I’m using a pointer and a crosshair too with my charts. If you want to add a drawing, you click on the Add Drawing button at the top of the chart, and you choose the drawing that you want.

For example, let’s add a trend line. When chosen, the pointer becomes the trend line, and to draw the trend line just click on one point of the chart and expand your trend line to another. And you can see that the cool thing about a trend line, the feature or the trend line drawing on the thinkorswim is that at the top of the trend line you have a number of bars. That price has moved from the beginning to the end of the trend line. You have the percentage move, the moving pips and the angle of the trend line.

Now, if you want to release the trend line, just click again on your mouse and the trend line is going to be released. Now, be careful because every time you draw on your chart, you have to go back to drawings and choose the pointer, so you don’t draw again a trend line on your chart. Now, let’s add another drawing to this chart. For example, let’s add Fibonacci retracement levels. You go ahead and click on the Drawing button at the top of the chart, and you click on Fibonacci retracement levels. But I’m going to show you another way to add drawings to your charts, and it’s this Quick button right here.

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You can see that we have a pointer right now here at the bottom of the chart, at the bottom left of the chart. And if you click on that pointer, the active tool will give you the dropdown menu for the drawings on the chart. And it’s like a hot button on your charting platform. So let’s add the Fibonacci retracement levels. Where are they? They’re here. You choose to add the Fibonacci retracement levels. You click on the chart where you want the retracement, and then you click again when you want the retracements to end right here. The retracements are added to your chart. Again, you have to go back to the button to the end to choose to have a pointer so you don’t accidentally draw a second Fibonacci retracement on your chart.

Now if you want, for example, to zoom in and to zoom out on your chart, just click on a portion of your chart with the mouse held and unclick it where you want the zoom in and out to end and right there. That piece of the chart has been zoomed in by thinkorswim. If you want to go back to the full chart, just double click on the Chart and there you go.

Now, I’m going to show you how to customize drawings on your thinkorswim platform because the default settings on the thinkorswim drawings might not be as good as you want them to be. For example, if you choose to draw a trend line, you actually want this trend line to extend to the right because you don’t only want to connect one this high and this high, but you want the trend line to be noticed to the right for when the price hits it so you can go short or if it breaks you can go long, for example.

Now, if you want to edit the conversation on a drawing, just click on the Drawing. By clicking on the drawing you activate the drawing, as you can see here. It changes colors, and it shows you the starting point and the ending point of the drawing. Then hover your mouse on it until you have that double arrow cross and right click on the drawing. In this case, the trend line. Then just click on these Properties and now you can edit the properties on the trend line. And you can even name this trend line. Let’s name it “basic trend line.”

And the one we want here is we want to change the color of the trend line, and to do so just click on the Color and select the color you want. In this case, we want a black trend line, and we’re going to choose the black color. And we want it to have an extension to the right. So we are going to activate the extension to the right right here, and we are going to set this trend line drawing as a default. Why? Because every time we draw a new trend line, we want this basic trend line to be drawn on, not the default thinkorswim trend line that has no extension and is red.

Then we’re just going to click OK, and you can see that the trend line has changed. To delete a drawing, just click on the Drawing once. To activate it, and click on your Delete key on the keyboard. Now, if you activate the drawing and wait for the double arrow cross to appear when you hover your mouse over it and right click, you can duplicate the drawing on your thinkorswim platform.

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How to Use Trendlines for Trading – Dispelling the Myths

Trendlines are a useful tool for visually highlighting a trend, and potentially being part of a trading strategy. There are a lot of myths and inaccurate information about trendlines though. Learning how to use trendlines effectively–if you are going to use them–is crucial so you don’t fall into several common traps.

Trendlines are a technical analysis tool used to define and project price trends in major markets such as stocks, forex, and futures. Trendlines have the potential to alert us when a pullback (move against the dominant trend) is over and the trend is resuming, or when a trend is accelerating or reversing (for more on trends, see Impulse and Corrective Waves). But price is the ultimate indicator. Therefore, price action (how the price itself is moving) must always be considered when using trendlines.

Here’s how to use trendlines for trading.

Whether you use trendlines or indicators, price action is what ultimately determines how much money we make. Learning about price action and how trends move is never a bad idea. Once we understand the basic concepts of how prices move, then trendlines become a more effective tool in helping us analyze that price action.

Prices constantly move up and down, even within a trend. While most traders know this, they have a hard time applying that knowledge in real-time. Traders often wait too long before entering, buying near the top of a price wave, or they panic as the pullback begins and end up getting out when the pullback is ending. Trendlines, discussed later, can help in this regards.

Figure 1 shows a basic uptrend. The uptrend begins by making a higher price high and then a higher price low (relative to the price waves that occurred prior). The price continues to make higher swing highs and higher swing lows. “Swings” refer to each major move up or down.

During an uptrend, we see this progress of higher swing highs and higher swing lows. When the price creates a lower swing high or a lower swing low, the trend is potentially in jeopardy. Once the price makes both a lower swing high and lower swing low (they don’t need to be in that order) then a downtrend could be underway–or it at least presents the possibility that we could see more downside. Trends can last for a long time and many waves, or they may only last a few price waves.

Figure 1. Higher Highs and Higher Lows – An Uptrend

During a downtrend, we see lower swing highs and lower swing highs. When the price creates a higher swing high or a higher swing low, the downtrend may be reversing. Once the price makes both a higher swing high and higher swing low (they don’t need to be in that order) it becomes more likely that the price could move further to the upside overall.

Pullbacks within larger trends, such as a pullback on a weekly chart, can often appear as trends on shorter time frames such as the daily or hourly chart (in figure 1, a pullback is the price move between the swing high and swing low). Even on the daily chart above, there are small waves within the larger labeled waves which haven’t been accounted for, which in real-time could cause some confusion. Reading price action is subjective; the basic concepts stay the same but how each person views the trend may vary slightly based on what they see and the time frame they are trading on.

Understanding the basic concepts of price action is crucial, because it applies to every trend we trade. If trading with a trend we want to see this type of movement–higher highs and higher lows for an uptrend, and lower highs and lower lows for a downtrend.

When a trend is no longer exhibiting these characteristics caution is warranted. It doesn’t necessarily mean the trend is reversing, but it does indicate a deeper pullback is occurring, or a reversal is potentially underway. Another key ingredient in reading price action is analyzing the velocity and magnitude of price waves, then comparing the velocity and magnitude of each price wave to the price waves around it.

How Trendlines are Useful for Trading

Price charts produce “noise.” Noise is the small random movements that can make it hard to spot the trend. Therefore, many traders prefer to simplify their charts. The uptrend in figure 1 is simplified by using a trendline, which highlights the trend and quickly shows the overall price direction.

This is very useful when looking at multiple time frames or when there are conflicting price action signals. By looking at the direction of the trendline traders can cut through the BS and see in which direction they should be trading.

Anytime there are two highs or two lows a trendline can be drawn. The trendline is drawn by connecting one high to the next, or one low to the next low. When starting out, draw as many trendlines as possible in all directions. This helps differentiate pullbacks and short-term trends from longer-term trends.

We also often have biases when we look at a price chart, which may not always be correct. By forcing ourselves to draw all relevant trendlines, especially at the far right of the chart (most recent price action), we may realize our initial bias wasn’t correct at all. Being able to see trends and pullbacks of different sizes will aid you in your overall analysis and chart reading abilities. This skill can then be applied to trading strategies based on price action and trendlines (see How to Day Trade Forex in Two Hours or Less).

How to Draw Trendlines on Your Chart

Trading software and charting platforms vary, but all of them should have a trendline or line tool. Select the tool. For an uptrend, connect the line from the low of one wave to the low of the next, and then extend it out to the right to provide a projection of where the next wave lows could possibly occur.

For a downtrend, connect the high of one price wave to the high of the next price wave and then extend it out to the right. The lines provide a projection for where future wave highs may occur.

If you are just starting out, TradingView.com is a free site with live real-time price charts, and great technical analysis tools.

Figure 2. Trendlines Drawn On a Chart

How to Use Trendlines for Trading – Adjustments Are Required

Trendlines are not only based on price, but also have a time element. This creates a great myth. Traders will often say that because a trendline is broken the trend is over. That is not true. The price could break through a trendline just because it look longer for a wave to complete. This is very common when the price is moving sharply higher or lower. For example, if the price is making rapid higher highs and higher lows, the trendline will be angled steeply upwards. That type of momentum can’t last forever, and eventually the trend will slow down. The price will break the trendline, but it doesn’t mean the trend is over, just that it has slowed down (as we should expect!). This is why we always consider price action in conjunction with trendlines.

Figure 3 shows an example of this. The price breaks the trendline but the price is still making overall higher highs and higher lows. It was crucial to monitor the price action, and not just the trendline, in order to see this was still an uptrend. The trendline was still effective in point a number of potential trade areas earlier in the trend (will be discussed a bit later).

Figure 3. Monitor BOTH Price Action and Trendlines

Trendlines will often need to be redrawn. They are not a perfect trading tool that tells you exactly where a trend will reverse. You will draw a trendline connecting highs or lows, only to see that the next price wave doesn’t match up with the trendline exactly. You now must decide if you want to redraw your trendline to accommodate these misalignments.

For a long-term trend, you may need to redraw the trendline multiple times. Alternatively, you may keep each of the trendlines you draw on your chart, showing the various stages the trend (near vertical, slow ascent, etc) has been through. This will remind you that conditions are always changing so don’t rely too heavily on the trendline… use price action analysis as well.

In figure 4, the price action isn’t very pretty, but trendlines help us see when the price is trending, when it is pulling back, and when it’s moving in a choppy fashion (no real trends present).

Ideally, if using trendlines for trading purposes you want to be trading assets with strong trending tendencies. A chart/asset like this one you would avoid since trading signals are harder to pick out. That said, for analytical purposes, trendlines help us see what is happening so we can strategize for the future (sometimes the best strategy is to not trade when conditions don’t warrant it).

Figure 4. Multiple Trendlines/Redrawing Trendlines, with Commentary

How I Use Trendlines in Trading

Instead of connecting exact highs to exact highs, or exact lows to exact lows, I draw trendlines of “best fit.” Trendlines only show us an “area” of potential interest, not an exact price level of interest. While textbooks show examples of beautiful trendlines where the price seems to magically bounce off them at exact levels, that isn’t usually the case in the real world.

A trendline of best fit connects as many highs together, or as many lows together, as possible. It is okay if the trendlines move through price bars (instead of running along exact highs and lows). The trendline still shows the overall movement of price, the trend direction, and provides areas of interest for potential trade signals (discussed next). The trendline also won’t need to be redrawn as often.

Figure 5. Trendline of “Best Fit”

How to Use Trendlines for Trading – Trade Signals

There are multiple strategies which could combine trendlines and price action. Here is one such simplified strategy:

—When the trend is up, if a pullback stays above the prior swing low and moves into the vicinity of the rising trendline, enter long (buy) when the price moves back to the upside (trending direction). Use a trade trigger to signal the actual entry, as discussed below.

—When the trend is down, if a pullback stays below the prior swing high and moves into the vicinity of the falling trendline, enter short when the price moves back to the downside (trending direction). Use a trade trigger to signal the actual entry, as discussed below.

Trendlines often need to be redrawn, therefore the price touching or moving through a trendline is not a trade signal on its own. We must also look at overall price movement. If the price movement warrants a trade it must produce a “trade trigger.”

A trade trigger is a precise event which tells us right now is the time to enter. The Engulfing Candle Strategy and the consolidation breakouts discussed in How to Day Trade Stocks in Two Hours or Less reveal entry techniques (trade triggers) and provide useful information for reading price action and using trendlines. These techniques are best used in conjunction with “trendlines of best fit.”

Trendlines help us keep focused and trading in the direction of the overall trend. The trendline provides an area where we should be on high alert for trading opportunities. This is especially true when using “lines of best fit” because multiple pullbacks have reversed near the trendline.

Fibonacci Retracements are also used in conjunction with price analysis and trendlines to find areas the price is likely to pull back to.

In the case of a downtrend, stop loss orders are placed just above the high of the current pullback. In an uptrend, the stop loss is placed just below the low of the current pullback. We can use the high and the low of the current pullback because we are entering once the price starts moving back in the trending direction.

The above is a quick guide to general trendline use. For additional reading, see How to Spot Trading Opportunities and the Day Trade Trending Strategy.

Drawing Trend Channels

Connect highs to highs and lows to lows during a downtrend or uptrend and you may end up with a trend channel. As discussed above, a rising trendline (connecting the lows) during an uptrend can provide area of interest for seeking long positions. The line which connects the highs during an uptrend is also relevant. It lets you know where the price has had a tendency to pull back from, and therefore can aid you in picking a profitable exit for your trade.

When drawing trend channels, trendlines of best fit are recommended.

Figure 6. Trend Channel Using Trendlines of Best Fit

Using Fibonacci Extensions can also be used to determine exit points, as the extension levels are drawn based on recent price action.

How to Use Trendlines in Trading – TakeAways

  • Trendlines are guidelines only, not exact levels. They provide areas the price could move to in the future. Don’t expect the price to move exactly to the trendline; it may not quite reach or it may overshoot.
  • Price action is important, and should always be used in conjunction with trendlines. Always be looking for higher highs and higher lows in an uptrend. If a lower high or lower low occurs, the trend may be in jeopardy. Look for lower lows and lower highs in a downtrend. If a higher low or higher high occurs, the downtrend may be in jeopardy.
  • Trendlines often have to be redrawn. You may end up with multiple trendlines at different angles for the same overall trend. “Lines of best” will reduce the need to redraw trendlines, although the best fit line may still need to be adjusted.
  • Trendlines can be drawn anytime we have two waves in the same direction. When starting out, draw lots of trendlines as it helps show short-term and long-term direction.
  • Trendlines are a visual guide to cut through noise, and therefore may aid in seeing trade setups. The trendlines themselves do not generate trade signals. Rather, we wait for a trade trigger near a trendline to get us into a trade aligned with the trend.

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4 thoughts on “ How to Use Trendlines for Trading – Dispelling the Myths ”

In a hypothetical strong uptrend, where the price has broken the overall/current trendline significantly but remains above the previous major swing low indicating that the uptrend is for the time being still intact, when and how do you look to re-enter long? Given that there are no visual aids such as a further trendline to indicate where support might exist, how do you determine which consolidation breakout is worth entering on, or is it a case of taking every opportunity till price proves otherwise?

Or is it simply a case of not taking trades that go beyond the trendline and to wait to see if the uptrend resumes, and then to look to enter a trade when price pulls back to the newly adjusted trendline? The caveat I see with this approach is that by the time this occurs much of the move may be over and the overall trend weakened.

Thank you very much for taking the time to read this rather long-winded question, and I very much hope to hear your thoughts on this subject.

Great question Jimmy.

First I would say that a trade should never be taken unless it is based on a pattern/strategy that you know. I swing traded for a while entirely on trend channels. I only took a trade if I a got a setup near my trendline. The strategy did very well, because if the price did something where it moved away from my trendline, I simply didn’t trade. I also only traded stocks and currency pairs that had a major tendency to adhere to these trend channels.

BUT, it is good to be more versatile than that. Sometimes prices respect trendline and channels very well, but lots of time they don’t. So some flexibility is good.

Trendlines are just a visual, but can also be deceiving when the price breaks through them but doesn’t actually change the trend.

That is why I always spend some time before a trade looking at how deep the typical pullbacks are. I do this while day trading or swing trading, and as soon as I pull up a chart I start looking for tendencies. Usually, I am looking for percentage retracements. For example, I may notice that a price often retraces about 60% to 70% of the last advance during an uptrend, before moving higher again. Of course, each pullback will be slightly different, but it provides a ballpark area to look for trades. At that point, I only take trades signals (such as a consolidation breakout or an engulfing pattern) that occur in that pullback area. I can then make adjustments to this based on the velocity and magnitude of the price waves currently underway (http://vantagepointtrading.com/archives/11068). You can also look for other little tendencies, such as how many little waves the pullback has (is it just dropping in one or two bars, stopping for a bar, and shooting higher? Or is the price making 3/4/5 little waves before reversing back in the trending direction—-all these tendencies can help determine when the best time to take a trade is).

For retracement percentages I don’t concern myself with Fibonacci ratios, but the Fibonacci tool is an easy one to use quickly see how far retracements are typically moving (http://vantagepointtrading.com/archives/10451)

So I am using the tendency of the stock/currency/contract to tell me where it is likely to go. And like I mentioned initially, I then only take trades when a trade signal occurs in that anticipated trade area. If forex pair usually retraces about 50% of the advance, I am only going to look for trades in that area (close to it, not exact). If the price only retraces 25%, and then forms a trade signal, I skip it. There will still be losing trades, for example, the price could retrace 50% (if that is the tendency), form a trade signal and then keep going against me. That’s a loss. Wait for the next opportunity.

Basically, I only take trades based on evidence that I can find, and that aligns with my broader strategy. Sometimes that may be a trendline if the price has shown continual respect for trendlines. Other times I may be looking for other tendencies. But unless I know what that tendency is, I don’t trade. If the chart just looks like chaos, I don’t trade.
I should note that these tendencies vary by stock, forex and futures contract. If day trading, they also vary by day. So I am always trying to pick out the relevant tendencies for that specific asset, on that specific time frame.

A lot more information here, but hopefully that helps you start to formulate a more concise plan for what you do in these situations.

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