The other day I talked to you about trendlines and how they can be used to improve your trade entries and exits.  

Well, it’s time we step it up and take it to the next level and talk about how we can use trendlines to spot where the big dogs are getting in and out of trades—the financial institutions that run Wall Street. 

Now that you understand the 3 key factors of a trendline we are going to add a 4th to the list.

Oh, in case you forgot what the factors are, I have listed them again for you.  

Trend Lines : 3 key factors

  1. The general direction current price is moving (upwards, downwards, sideways)
  2. Strength of the current price movement
  3. Future support and resistance zones

 

But there’s more

You’ll learn how to::

  1. Predict massive momentum
  2. Know exactly the entry price to trade at

 

It can be extremely difficult to time your trades even with the above tools to help.  

So what is the solution?

Trade using a trend line breakout pattern!

 

The Problem

 

It can be very difficult to time entries in a trending market if a trader is only looking at pullbacks.

Why?

Well, how do you know if the pullback is going to be “shallow” or “deep”?

Meaning, how do you know exactly when it will stop?  

There have been many times when I heard traders say things like 

“That stock should have bounced there”

“That stock shouldn’t keep going lower” 

But that’s the problem…

The stock doesn’t bounce where the trader expects

The stock keeps going lower

Both of these will make even the most experienced traders panic resulting in poor trades and significant losses.

So, what’s the solution?

 

The Trendline Breakout Strategy

 

This is strategy will change the way you look at buying trend lines.

The breakout strategy focuses on high-probability setups with high risk-to-reward setups.

This pattern is designed to ensure that the trader enters at correct levels on their trade.  Aiming to avoid the costly mistake of “catching a falling knife”.

This is how it works…

Trend Line Breakout Strategy – 4 steps::

  1. Wait for a pullback in an uptrend.  
  2. Draw a trendline that connects the highs of the pullback.  
  3. Enter the trade once price breaks above the upper trendline.
  4. Place stops at pivot low to protect the trade.

 

Let’s take a look at these in action on the SPY’s using intraday charts.

When it comes to intraday trading I like to focus on the SPY,QQQ,DIA or other extremely liquid ETF’s for this strategy.  

That’s not to say this pattern won’t work on stocks as well.  

In fact, it works on almost everything ranging from 1m chart to daily charts and stocks to FX markets.

Be sure to keep in mind that stock-specific trading carries additional market risks to be aware of.

 

Intraday SPY Long

 

Let’s start by taking a look at an intraday trend line breakout on the SPY’s. 

This is a very active trading style in the direction of the trend.

 

 

As you can tell by the chart above its many countertrend breakouts a trader can capture throughout the entire day. 

The trade:

  1. Identify the defined trend
  2. On pullback, draw the trendline to identify entry point.

 

Since this is a trade in the direction of the trend, sell on break of trendline.  Typically a trader is not required to wait for a pullback as it seldom occurs.

 

Intraday SPY Short

 

Similar to the uptrend breakout, a trader can take advantage of a downtrend breakout as well.  

In this example, let’s take a look at the SPY’s that are in a defined downtrend and has a series of pullbacks that a trader can execute short positions at.

 

 

In the image above, the SPY is in a well-defined downtrend and, with each pullback, there is an opportunity to execute a short position.  

This gives the trader excellent risk-to-reward trading in the direction of the trend.  It is always best to wait for a pullback instead of chasing momentum lower.

The trade:

  1. Identify the defined trend
  2. On pullback, draw the trendline to identify entry point.

 

Since this is a trade in the direction of the trend, sell on break of trendline.  Typically a trader is not required to wait for a pullback as it seldom occurs.

 

Identify trend reversals

 

Have you ever seen the price break above the downward trend line and then you think, “the market is about to reverse higher because the trend line has been broken.”

Then before you know it, the market heads lower and resumes the downtrend leaving you with a long trade and taking losses?

Remember, just because the trend line is broken doesn’t mean the trend is over.  This is called a “false breakout” and is common!

3 steps to follow to identify a reversal pattern:

  1. Wait for price to break above or below the trend line
  2. Wait for a higher low (or lower high) to form.  This shows the new trend is strong
  3. Price breaks a prior swing point or retests trendline and holds, it then confirms the new trend.  

 

Long Reversal

 

Instead of trading in the direction of the trend, a trader can use the same technique as a reversal pattern.

 

 

In this breakout example, a trader would connect the swing high points to create the new descending trendline that he would anticipate a breakout and reversal from.

This trade sets up in two steps:  

  1. Watch for the breakout.  Initiate your trade once the breakout is confirmed.
  2. Enter additional position size when retest is held.

 

Pro Tip: If you are a more conservative trader, you can wait for the retest before initiating a position.  By waiting for the retest of breakout you achieve the highest risk-to-reward ratio. Be aware, you may miss momentum breakouts where a retest is never seen. 

There are many “patterns inside patterns” in the lower intraday time frames.  Be sure to identify the major trend and if you are looking to trade in the direction or against it. 

It’s important to make sure to choose what pattern fits your trading style the best.

 

Short Reversal

 

Another way to utilize this idea is to trade it as a reversal pattern.

 

 

Above, it appears the SPY’s are about to breakout higher with a “triple top” also forming.  

Failing to do so indicates strong negative pressure on the stock.  

Looking to the perfect entry for a trade lower you would draw your major trendline showing the uptrend the stock is currently in.

Let’s break this trade down into events that drove this price action in the SPY’s:

  1. Failed to make new highs 3 times during the day.  
  2. Traded in the direction of the major trendline.
  3. Broke the ascending trendline support and retested prior to heading lower.

 

See exactly what kind of power this trading pattern has! 

 

Weakness Of Trendline Breakouts

 

As powerful as this trading pattern is, I must warn, it comes with some pitfalls.

One of them is trading stock where the trend goes parabolic.  A trader will risk giving back a lot of open profits or take significant losses when this occurs.  

Trading when the range of the candlesticks are increasing at a fast rate makes for poor risk-to-reward trading levels.  

One way to prevent large losses if finding yourself in a parabolic trade is to place stop losses on the current market swing and exit the trade if price closes below it for long trades.

 

Final Thoughts

 

So let’s recap:

  • When you draw a trendline, make sure to focus on the major swing points by connecting them and forming the major trend.
  • The trendline breakout strategy helps time markets in for trend and counter-trend trading
  • If a trend line breaks in a reversal pattern, wait for re-test and confirm it holds.  If it does, the market is highly likely to reverse in the opposite direction.

 

Are you ready to put these tools to the test and trade the SPY’s with sniper-like accuracy?

 

Author: Ben Sturgill

Ben leads two services at RagingBull. IPO Payday can help you pinpoint, position, and profit from IPOs. In Daily Profit Machine Ben guides day and swing traders to profit by trading the SPY Index. Ben hosts the RagingBull.com weekly podcast WealthWise where he shares thoughts on wealth and success with traders, businesspeople, entrepreneurs, and experts to uncover and share the wisdom needed to live a wealthy life.

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