Trendline Strategies using Price Action Analysis

This post intends to continue what was previously posted here. Knowing the importance of candlesticks, the patterns they form, and their crucial importance when the price reaches trendlines or support-resistance levels, I make here a simplified summary of my trendline strategy for day-trading, using Price Action Analysis. For this, I will rely on the charts from Forex.doc, which are among the best explained and drawn that I have found on the internet. Thanks to their authors for permission to publish some of them here.

Trendline Strategy: Basics

A trendline connects swing highs or swing lows during a trending market, and can act as support or resistance line, but also a break of it can signal a trend change.  In an ideal uptrend, price make higher highs and higher lows. In an ideal downtrend, price make lower highs and lower lows.

The strategy is based on the breakouts and pullbacks made by the underlying's price:
 - A breakout is a potential trading opportunity that occurs when an asset's price moves above a defined resistance level or moves below a defined support level on increasing volume. 
- A pullback is a pause or moderate drop in a stock or commodities pricing chart from recent peaks that occur within a continuing uptrend.

- Use top-down multi-time frames. For example, for a day trader, the most useful are daily, 1-hour, and 15-minute (or 5-minute). I usually avoid the less than 5-minute or tick charts: too many signals and "noise" is generated.

Timeframe 1: Daily chart

 - As a guide, define here "the big" trend (bull, bear, or sideways) through a swing-highs-lows pattern. Use the exponential moving average EMA50 to confirm bias: uptrend or downtrend.

- Draw daily-chart lines: up or down trendlines (lines that connect swifts), obvious horizontal levels (support-resistance, Fibonacci and psychological), and price patterns (triangles, channels, wedges, flags, head and shoulder, double top-bottom, and trend-change).

- Notice that the 4-hour chart is a great alternative to the daily chart, as it is more quick and gives more detail in periods of a strong trend in the markets.

Timeframe 2: 1-hour chart

- Define in this timeframe "the tradeable" trend (not the ideal case, but can differ from "the big" trend) through a more accurate swing-highs-lows pattern. Use the EMA50 to confirm bias.

- Draw the 1-hour lines: immediate uptrend or downtrend lines and recent horizontal support-resistance levels.

- Define the key area in the intersection of daily-chart lines with 1-hour lines. If it doesn't appear, choose the main trendline or horizontal level from any of these timeframes.

Timeframe 3: 15-minute chart

- Draw 15-min lines: more immediate (so, accurate) trendlines, daily pivot-points, and tradeable EMA50. You can also include the VWAP, followed by investment funds and smart-money in its day trades, and therefore an important indicator.

- Wait patiently, until price approaches the key area (or main trendline) for a probable breakout.

- When price action touches it, look for a price reaction (rejection, pause or momentum loss, momentum, reversal) through the respective candlestick pattern (pin-bar or long-wick, inside-bar or harami, no-wick, hammer, shooting star, engulfing) or other pattern combinations (bigger candles, multiple-rejections, shrinking, color-change candles). 

- Always verify volume: as increased, reinforce the power of the candlestick pattern.

- Finally, use the trendlines in two ways: for trend trading and reversal trading, explain below.

1. Trend (Continuation) Strategy

Verify-in any timeframe if price action applies for a trend strategy through a price reaction formed after reaches the trendline or recent support or resistance line. For this retest, use the more immediate trendline. 

2. Reversal Strategy

Verify-in any timeframe if price action applies for a reversal strategy through a price pattern (best: double top-bottom or a trend-change) formed before the trendline break. Personally, it is the strategy that I prefer because it involves a greater number of signals than the continuation strategy.

- The key: in any case (trend or reversal strategy), after the breakout, wait for a next candlestick pattern confirmation to decide the entry. Otherwise, it's a false breakout.

- Always take into consideration that price and volume are the foundation of Price Action Analysis, no technical indicators are necessary.  Perhaps the RSI would be one of the few, to review the overbought or oversold status of the stock, but never to generate trading signals.

- As you have seen, I focused exclusively on simple price setups. This kind of simplicity, hard to grasp at first, is, in my opinion, the most successful way to trade, obviously, after many hours of observing and analyzing the price action in the charts.

Applying the theory

Last two weeks the SP500 had a very predictable behavior in its price action: the holy grail of any swing trader. As the big trend in the daily chart (not shown) is bullish, we use this 1-hour timeframe for more details: analyze the continuation of that bias or unlike, a short-term pullback. After the Monday explosion, the SPY price began losing momentum and showing candle rejections in the midday Tuesday session, especially when touches the Fibonacci level of $313.22, the green line. A breakout opportunity could appear there, or not... be patient.

Let's review what happened last week with the SPY, through its 1-hour chart, below.

It happens on Wednesday: a double-top pattern was formed (grey box), so we need to wait for a breakout of the immediate trendline we draw (yellow line). When price broke it, a big momentum candle appeared, with increasing volume: that's the confirmation of a reversal. Go ahead to the 15-min chart (not shown) to decide the correct place to enter your short trade. Place your stop loss in the double-top level and trail it for lock profits. Wait until the price approaches the most recent swing-low level (near $310, the yellow upper-narrow) to decide if exit the trade.

The exact behavior was repeated in the SPY three more times with the same typical move (!): rising to a level forming a double-top, an immediate trendline break (also breaking the black-line EMA50, which reinforces the signal), and a big momentum candle confirmation with increased volume. Surely, more great swing trades opportunities are coming with the double-top and double-bottom patterns. 

That's why I told you that technical analysis seems more accurate than usual this 2020. Just follow your strategy as I do with mine. And be patient, as a sniper, waiting for the opportunity.  Remember trading is not just charts: it's mostly risk management and psychology (patience, emotional intelligence, discipline...)