How Can Traders Use Trendlines?

Bob Iaccino, Chief Market Strategist and Co-Founder of Path Trading Partners, joins us live every Thursday from 11am ET, as our risk management educator.

With 30 years' experience working as an active investor in equities, commodities, futures and FX there are few better to talk on the subject of risk management.

Bob has developed a method for breaking down his key fundamentals of risk management, in a way that he thinks retail traders can understand and use to get actionable insights to bring into their own trading.

Below are some excerpts of Bob’s thoughts from a recent live session.

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What EMAs form rotation zones?

It's the 21 and the 8 EMA that form the rotation zones.

The number one thing you should know is, the rotation zone is those two moving averages in whatever period you're looking at. If it's a 30 minute chart, it's an 8/30 minute period

EMA and a 21/30 minute period EMA.

If it's a daily, it's an 8 daily EMA and 21 EMA and so on. If it's a weekly, it's 8 weeks, if it's an hourly, it's 8 hours. They’re period EMAs, not time. Some people have an 8 day EMA and they have that same one on all their charts, it's at the same level. Not with this.

Number two: I pay attention when the EMAs cross, but I don't trade when the EMAs cross because they cross a lot. What I pay attention to is cross 1, 2, and 3 and depending on which asset and which direction it's going, sometimes 4. What I pay attention to is after they cross, do they move in a direction? Do they steepen in one direction or the other, either up or down and do they begin to separate? If they do that, we have a rotation zone.

Just by having those EMAs on the chart, does not make a rotation zone, they must have a certain shape to them. They have to be angled widening out and then I look for the first, second and third test of those rotation zones. If the test holds, I can go in the direction of the zone. That's what I use them for.

How can traders use trade trendlines?

To help address the issue of a consistent method to draw and use trend lines, let’s consider a different way to draw trendlines. These trendlines are called trade trendlines and they only require two points to be properly drawn to draw a trade trendline.

The two required points are called the initiating point and the defining point.

The initiating point is similar to the traditional trendline initiating point, and it's the point from which the trendline initiates, where it starts.

The second point required to draw a trade trendline is called the defining point, and the defining point basically decides what angle the line is on. A trendline is drawn by connecting the initiating and defining points.

To find a valid defining point for an upward sloping trend line, start from an initiating point that is at a major swing low. Move bar by bar to the right. Connecting the initiating point to the next bar’s low. If the trendline that is drawn cuts across any price action at all to the right, or any future price action is below the trendline, then it's not a valid defining point.

In that case, you must move to the next bar's low. If price action does not touch a trendline and the trendline is upward sloping, then you may have found a potential defining point.

A defining point is confirmed when the bar after the defining point closes and no portion of that bar touches the trend line.

What constitutes the defining point of a trendline?

A confirmed defining point can become the initiating point of another shorter trendline.

Start with a confirmed defining point, using it as the initiating point, and repeat the trade trendline rules. Move bar by bar to the right, connecting the initiating point to the next bar’s low. In the case of an upward sloping one, verify no price action to the right is touching the trendline and confirm that you have a defining point for the new shorter trend line.

When should trendlines be drawn?

Wait to draw trendlines until the bar that confirms the defining point has closed or is nearly closed, otherwise, you'll constantly be drawing potential trendlines that do not become confirmed trade trendlines. Remember, the bar after the defining point cannot touch a trendline at all or it is not a valid trade trend line.

A trendline remains valid until it's broken and there is a valid redraw. If the trendline has been broken but there is not a valid redraw, then the trendline remains in place until there is a valid redraw.

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