So as the market continues to make all-time highs I can’t help but wonder… are we being fooled?
Today I want to look at how to trade trendlines, but first, let’s take a look at the trendline on the SPY and figure out what the heck is going on.
In the chart below, the SPY is in an uptrend. The SPY’s trendline (blue line) is drawn by connecting as many higher lows as possible while keeping a straight line.
Every time the SPY hits the trendline, it acts as support and it bounces off. An interesting note here… the 200 day (green dotted line) is riding right along the trendline.
We all know the significance of the 200 day as a major support level in uptrends, thus giving this trendline even more significance.
So how do we know if the SPY is overextended or not?
As with any uptrend, the SPY bounces off the trendline, moves up, hits a peak and retraces to the trendline again… but at a higher level each time.
Prices are often drawn to the 200 day like a magnet… so even though it’s moving up overall, we get retracements.
Where this gets interesting is to note how far the SPY extends before it reverts back to the trendline…
When measuring the distance between the 200 day and the peak before the SPY retraces, we get a peak that is around 8 – 9% above the 200 day.
And just yesterday, the SPY hit a high 9% above the 200 day… Time for a pullback?
I don’t know, but markets don’t go straight up.
With so many tools out there to find great trades… why use a trendline?
For one, using the trendline in the SPY chart with a simple measurement to swing highs has provided insight to some very profitable trading opportunities.
And I’m going to take it a step further and show you exactly how I use trendlines to grab profits each and every day.
It’s a simple fact… stock prices are known to trend, so there is value in identifying that trend…
A trendline is nothing fancy, it’s just a simple tool that will give you a quick view of the direction of a stock (the trend).
A trendline is a straight line connecting two or more price points. As it extends forward, it acts as a line of support (uptrend) or resistance (downtrend).
Because of that, many of the principles applicable to support and resistance levels can be applied to trendlines as well. To learn more about support and resistance check out my article.
And adding a trendline to a chart is super easy too.
Start at the left side of the chart and extend a line going to the right… if a stock is trending up, you would connect the higher lows in a straight line upward…
And if the stock is trending down… connect the lower highs in a straight line downward.
Trading A Trendline
When looking to trade, you first want to identify the trend…
Where an uptrend is marked by an overall increase in price, we all know a stock isn’t just going to move straight up.
It is going to stall out, pullback, go up, create some support and resistance levels, move around those some, etc.
You see a lot of people can’t handle the swings, so they get chopped up.
But we understand that stocks need to breathe and how to make money by using that natural movement to buy and sell at the right moments.
Let’s look at a basic entry pattern on a trend trade…
AMAT is in a clear uptrend with the blue trendline connecting a series of higher lows.
On each retrace, you would have a chance to either buy close to the trendline for the next move up. As price reaches the trendline, you could use different candle or chart patterns to enter as the stock bounces there.
Another way to trade this trend is to buy a break above the previous high.
Once the stock bounces off the trendline… confirmation of the trend continuation is above the previous swing high. So you would look to get in as it breaks above.
The swing highs in the AMAT chart are all pointed out in the blue boxes. So you would be buying above each of those looking to profit off the extension.
It’s almost that simple… but so many people just can’t do it. So let me show you an example from a trade I took to show you how easy it really is when you look at things as a whole.
REI Trendline Trading
I trade every day in a live chat room, so my members get the benefit of knowing my every thought while trading. In fact, you could say I even hold their hands through each and every trade… click here to gain access.
As for REI, there are a number of things lining up in this chart… and that’s what I love.
After consolidating in a trading range for 2 months, REI broke out making a nice move up.
After the pop, the key to starting a trend was a higher low on the pullback… holding support at the trendline, REI started it’s next move up.
Now we were actually blessed with two trades here. The first one was on the break above consolidation. Here’s how I played it…
On Nov. 7, my scanner picked up REI as it traded above the consolidation range… I watched it towards the close and seeing continued strength, I was convinced there would be follow-through into the next day… so I got in.
And over the next two days, we saw the pop I was looking for.
The second trade setup in REI was on the pullback when it was holding at the key level of the breakout point… this is when I like to play the trendline support.
If you take into account it’s making a higher low right at the breakout level, this is a great setup with low risk back up to the 2.54 swing high.
And if we see a break above 2.54, there would potentially a 3rd trade here…
It just hasn’t set up yet.. but if the newly forming uptrend holds, the next buy would be above the previous swing high of 2.54 with a target to resistance between 2.80 and 3.19 (the 200-day moving average).
Right there in just one chart, you got 3 different examples of how to use a trendline to trade. In case you didn’t catch it, the key was noticing the importance of each level layering on each other.
The breakout happened above 4 swing highs from consolidation and the pullback holding and bouncing at the trendline lined up with support at the breakout point.
Putting all the pieces together really isn’t hard, you just need a mentor to walk you through it while you learn.
If you want a chance to trade with me each step of the way, while I explain it all and answer any questions in my live chat room… don’t wait to get the mentorship you need.