TRADING TECHNIQUES


A Winning Game?

Trading Trendline Breaks, Part 3


by Sylvain Vervoort
In the first part of this series, we examined the application of trendline breaks. In the second part, we studied a basic system for creating trendlines. This, the third and final part of this series, takes a detailed look at how the system can be applied.

Previously, I discussed how trendlines are plotted and how they can be used. This time, I am going to show you Abercombie & Fitch Co. (ANF). The numbers here represent the labels on the chart displayed in Figure 1:
 

FIGURE 1: ABERCROMBIE & FITCH (ANF). On this chart you can see the trendlines as well as the entry and exit signals generated by the trendline break simulation system. You can see that the decisions made by this system are in line with the breaks in the manual trendlines.
1. There is a clear downtrend line break. There is a buy signal generated by the trendline break simulation system (green up arrow) at about the same level of the trendline break. You open a long position. Typically, you would set a stop-loss just below the previous low.
2. The next trend is up.
3. In February the trend starts accelerating. You could either go for the red uptrend line at the beginning of the acceleration or the blue uptrend line that starts shortly thereafter, which is even sharper. Applying the trendline rules as proposed in part II, you would, however, end up trading along the red uptrend line.
4. The end of the sharper uptrend line is not important because you would end up closing your position at around the same price (the blue exit sign), whether you are following trendline 3 or 4.
5. The sharper uptrend line that initiates from trendline 3.
6. The last top is a typical example of a sharp move down at the top. In such a scenario, you should wait a couple of days before you start to draw the downtrend. This is because you want it to start from a different bar than the high bar. When this downtrend line is broken, you can open a new long position.
7. The uptrend line that started in May is broken. You might as well accept that the trend is beginning to slow and is near the end. There is another less steep trendline that also is broken. In both cases the trendline breaks take place before the system exits.
8. The downtrend line is broken, which means you can open a new long position.
9. The uptrend line is broken. The long position is closed. Whether you were using the break of the sharp uptrend line or the break in the longer-term uptrend, the system would close the position at around the same time.

The decisions made by the simulated system test are in line with the breaks in the manual trendlines. In fact, entering and exiting positions based on the manual trendline may have been more profitable.
 

...Continued in the October issue of Technical Analysis of STOCKS & COMMODITIES


Excerpted from an article originally published in the October 2007 issue of Technical Analysis of
STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.



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