Breathing and Counter Trend Lines

Breathing and Counter Trend Lines

Most people, in order to survive, rely on the age old practice of breathing. This breathing process adds oxygen to our lungs and eventually to our blood where it can invigorate and assist our bodies. Breathing involves both breathing in and breathing out. Some people can breathe in and hold their breath for long periods of time.Many stocks follow this same breathing pattern. They move up for a period of time and then move back down, just not as far. This pattern is known as an uptrend. Once an uptrend has been established, traders may want in. Establishing an entry is a key facet to any trading plan, especially traders who want to be consistent and disciplined in their approach. One type of entry that waits for the stock to stop breathing out and tries to catch it just at the switch to breathing in is Counter Trend Lines.

In order to understand counter trend lines, we first need to understand a trend line. A trend line is a line drawn on a chart that connects a series of higher lows or lower highs. This line is important for 2 reasons. The first reason is the line represents the trend. The second is that when the line is broken, that trend is over.

The rising dark trend line in the chart represents the trend. This is also the base line for breathing. It is connecting the previous lows and demonstrates rising support. Remember support is drawn as a general area, so it will not always align perfectly. Also remember, the trend line should include almost all of the price action. It would look something like this:

counter trend lines

Now that we have an established trend, we can begin to notice the counter trend lines. Counter trend lines are drawn when 3 or more points on the chart, usually daily highs, lows or closing prices align. They are connected with a line that is traveling in the opposite direction of the overall trend. In the example listed, the down red lines are the counter trend lines. The consistent and disciplined entries happen when the stock or ETF in question closes above the counter trend line. Thus the dark line is the breath in and the red lines are the breathing out. Not all stocks or ETFs trade this way so make sure it fits as you begin to apply this strategy.

Instance #1 is where is the stock tops and then begins to drop for 3 days and then goes back and forth for a few days until it clearly breaks the line after threatening to break the line the day before.

Instance #2 is the worst of the bunch. As the stock topped and pulled down for a few days it gapped down and then went sideways until it broke back up, without lining up too many highs or lows.

Instance #3 is a little way away from the uptrend line but it is the instance where the price clearly started below the line and clearly closed above it at the end of the day. In the book Technical Analysis of the Financial Markets John J Murphy states “a close beyond the trendline is more significant than just an intraday penetration”. With this being the case, one could have gotten in at the end of the day with limited risk.

Instance #4 took a lot longer time to play out. It did pull back the furthest but it also touched the uptrend line and showed strength, bouncing off of it. It then continued it’s up trend.

As you look to apply this concept remember the keys to drawing trend lines are: 1 Connect multiple points (at least 3, the more the merrier) 2 Draw trend lines that are relevant to current price. Best of luck in your continued breathing and trading!