How to Time Trade Entries and Exits with Trend Lines

08/25/2011 7:00 am EST

Focus: STRATEGIES

Corey Rosenbloom

Founder and President, Afraid to Trade

While all traders can see a trade setup followed by the successful outcome in hindsight, the trouble-and profit-lies not just in being able to see a setup as it occurs, but then taking the extra step to act on it with an order in real time as it unfolds, with all its imperfections.

If you're like most traders, you struggle to know exactly "When do I enter my trade?" or alternatively, when you do hold a winning intraday trade, and struggle to answer the opposite question, "When do I take my profits?" when the trade has run its course. While there are dozens of different types of trade setups to take and more trading strategies than you can imagine, most traders will benefit from keeping their entries and exits as simple as possible. What better place to build a foundation for entering and exiting trades than intraday trend lines!

You must always know in advance what specific signal-perhaps from an indicator or the break of a certain support or resistance line-will cause you to enter a position. If you are uncertain, take a quick moment to see if the market has formed any obvious trend lines that can guide your decisions.

You have likely heard trading educators speak of the importance of price, but might not know exactly what they mean, especially when so many indicators seem to be very helpful in locating trades for you. Keep in mind that if you use too many indicators, you are likely to confuse yourself about where exactly to buy or sell and may even develop "paralysis by analysis." As an intraday trader, that's certainly not desired!

To make matters worse, if you incorporate multiple time frames into your intraday trading decisions, you might find price overbought on a 30-minute chart and be prepared to short sell it, but then find it oversold on a five-minute chart.  What do you do then? Similarly, you may find price above a 20-period moving average on a 30-minute chart, indicating a bullish posture, but then find it beneath the 20-period average on a five-minute chart, signaling a bearish posture.  The result is that you'll probably stand on the sideline as the market takes off without you.again.

However, price is the same on all time frames-you'll find the signal from price breaking a trend line on all respective time frames at the same moment-only you'll be able to see it clearer on the lower time frames. It's often easier to make a decision based on a higher time frame structure (such as "I want to sell short based on this signal") and then execute the decision through simple trend line breaks on a lower time frame, which emphasizes more detail, rather than analyzing both the higher and lower time frames in exquisite detail.

Before we see the charts, let's review some of the basic concepts of trend lines.

Trend Line Basics

  1. Trend lines need to touch at least two points to be valid, though the more price points the trend line touches, the better.
  2. Trend lines that have lasted a longer period of time are more valid than those of shorter duration.
  3. The steeper the trend line, the more likely it is to be broken.
  4. Think of a trend line as a zone, not an absolute price.

Validity refers to the ability of the trend line to serve as an ongoing trend line into the future. For example, if we have a rising trend line, we would expect it to serve as support if price touches or tests the trend line in the future. When price touches a valid trend line, you can enter a trade in the expectation that the trend line will continue as a retracement trade. Your stop would be slightly beneath the trend line.

However, the best price trend line signals, from a trade entry and exit perspective, come from the breaking of a valid trend line, which is a type of reversal trade signal.

If you are trading long and price has been bouncing higher off a known trend line, it is an instant "take profits and exit" signal when price breaks sharply under the rising trend line, answering the question "When exactly do I take profits?" Keep trading from the long side until a dominant trend line is broken.

The original question of "When exactly do I put on a trade?" is answered similarly, particularly when you have a valid trade setup from your indicators, but don't know exactly where to trigger the specific trade entry. If you are not already holding a position and then see price break a known trend line, then you can trigger an entry on a close beneath the trend line, particularly if you are seeing overbought or divergence signals from your oscillators or in intraday market internals (such as the TICK, breadth, etc.).

Many times, your indicators will identify a condition for you, such as "The market looks ready for a short," but the break of a trend line, especially as seen on a lower time frame chart, will provide you the exact level to put on that trade your indicators signaled.

I don't intend for you to remove all indicators, because we all use different strategies, but for the purpose of this article, I will be showing pure price charts and highlighting how trend lines can help you make more efficient decisions.

NEXT: An Intraday Trading Example

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An Intraday Example

First, let's see the transition from up to down that allowed intraday traders plenty of opportunities from April 22 to 27, 2010. For a proxy, I will show the @ES E-Mini S&P 500 June contract, though this certainly would have been as effective in the SPY ETF or any other equity index trading vehicle, including leveraged ETFs. The concept also works well when trading volatile intraday stocks for quick profits.


Click to Enlarge

Figure 1: S&P E-Mini Five-Minute Chart

Starting with the two price lows from April 22, you could have drawn a trend line higher from that point forward. Price retraced back to this trend line at 10:30 am CST (labeled "A") the next day just above 1,200, allowing you to execute a buy trade with a stop just under 1,200. If by chance you missed entering on this first official pullback to the trend line, then your second-chance entry came an hour later (labeled "B") as price broke to the upside of the shorter-term descending triangle that I drew from the morning price highs. Remember, short-term trend lines are more likely to be broken (or are less valid) than longer-term trend lines, and as such, can provide great entries like this example.

If you look closely, price broke the trend line on a strong bullish candle. Where do you execute your trade? If you are looking to put on a buy trade anyway, you can enter immediately as price breaks above a trend line. You could have treated this as a bull flag, and in fact, most price patterns involve trend lines. Actually, when you short sell from the price breakdown from the horizontal neckline of a head-and-shoulders pattern, you are entering a trade based on the break of a trend line. You want to get short as soon as possible and execute as close to the breakdown as you can. That is the case with intraday trend lines.

Price rallied higher from the first entry at the first test of the trend line and the second-chance entry at the breakout above the descending trend line during the morning session of April 23, 2010.

Price pulled back a number of times back to the zone of the rising trend line, giving additional entries along the pathway higher. You actually could have remained long (in buy mode) until price broke the dominant and valid rising trend line, which finally occurred just before noon CST on April 26 (labeled "C").

This answers the question "Where exactly do I take profits?" Consider doing so on a firm break (notice the sharp down candle bar) of a valid trend line. For reference, there were negative momentum divergences along with negative divergences in market internals, all of which hinted that odds favored a reversal in trend. However, divergences do not tell you when exactly to exit or sell short by themselves; and neither does an overbought oscillator. That's where trend lines can help!

The breakdown at "C" at noon was a nice "take profits" signal at 1,213, but notice that a horizontal support trend line had developed at the 1,211 area. Price found support three more times off this level and formed a less-than-perfect head-and-shoulders pattern with the horizontal trend line now serving as the neckline for the price pattern. A trader aims to short sell the breakdown from a head-and-shoulders pattern.

The official trend line break at "D" triggered as price fell under 1,210.50 on another powerful sell bar, which triggered a short-sell entry on the break of the horizontal trend line at 1,211. It would be best to place a tight stop above the two swing highs at the 1,213.50 area, or a wider stop above the intraday high of 1,216.50.

If by chance you missed entering a short-sale trade as the day ended on April 26, you had another second-chance entry similar to the "B" in the rally phase. Price retraced higher, forming a rising short-term trend line that formed another type of bear flag pattern. Price officially broke under the rising trend line at 10:00am CST at 1,206.25, triggering another short-sale entry for you, while suggesting a potential stop-loss above the intraday high at 1,208. Price fell very sharply after breaking this short-term trend line, giving you a windfall profit if you were short from either previous trend line break.

Conclusion and Summary

While most traders are familiar with trend lines, we tend to think that trend lines are only for new traders and that our advanced methods will outperform simple trend lines. However, sometimes it's very helpful to return to the basics and execute trades based on what works, rather than what is supposed to work.

How exactly can trend lines enhance your trading strategies?

  • Trend lines enhance retracement trades by giving us an entry as price retraces to a valid trend line in the context of an uptrend (or downtrend)
  • Trend lines enhance reversal-style trades when price breaks under a long-term valid rising trend line in the context of a lengthy uptrend that is showing signs of reversing (divergences, etc.)
  • Trend lines enhance breakout trades (such as triangles, rectangles, and wedge patterns) once price breaks outside the converging trend lines during a price compression

The next time you find yourself asking "When exactly do I enter?" or "When exactly do I exit?" take a journey back to Technical Analysis 101 and dust off your trend line tools-they're on every single charting software package available to you for a reason. They can help you answer these questions and guide your trading decisions in times of uncertainty or in the heat of intraday battle.

By Corey Rosenbloom, CMT, Afraid to Trade.com

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