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The Traders Wheel
3/22/98 by Alan Farley

 

Psychotic Trendlines

Original thinking leads to profits in short-term trading. Even the simple process of drawing a trendline allows unique ways to look at the markets. Common TA wisdom sees a trendline whenever 3 or more relative highs or lows can be connected in a straight line. "Filling in the dots" sketch lines under rising trends and over falling ones. But using BOTH highs and lows to locate drawing points will create many legitimate trendlines as well. These psychotic trendlines contain predictive properties that traders can use for profitable entry decisions.

Logic dictates that drawing a straight line across any 2 relative highs or lows produces a random extension with no predictive force. But in his best-selling book Methods of a Wall St Master, Vic Sperandeo proved this 2-point method could locate breakouts when combined with specific drawing and trading rules. Psychotic trendlines can be utilized in a similar manner. But since they represent pivots as often as support/resistance levels, a simple buy/sell at the line won’t work. So how can they assist us in our trade preparation?

First locate these original lines on a chart of interest. In addition to highs and lows, PTs tend to cross right through gaps. Once located, identify the tendency of the PT by its slope (up or down) and whether it acts more as support or resistance. In a vacuum, trade in the direction of the bias. For example, if downsloping and resistance, the sell should be better than the buy.

The real power of psychotic trendlines comes when combining them with the pattern landscape. Quite often, they will intertwine with double bottoms, tops, channels and first rise/first failure retracements. PTs can then be used as a method of cross-verification. In this process, they set up right at the point where pattern features expect a breakout, breakdown or major reversal event. If price then gaps, it confirms a breaking event while candle reversals confirm a swing event.

One of the simplest methods for predicting PT behavior is to assume support/resistance will hold the first two times that price strikes it and fail the third. But this tendency can’t be relied upon unless other elements of your analysis confirm it. And make sure you look for psychotic parallel price channels as well. These can appear and disappear for years through the axis of a market’s constant up/down swings. When multiple PPPCs criss-cross, they point to converging events that carry very high reward: risk.

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The classic green downtrend line in SBUX’s 1998 correction contrasts with 3 psychotic trendlines that predict key trend thrusts during the decline and subsequent recovery. Note how gaps defined at least 3 of the line points. PTs identify one method to predict price gaps in advance of this powerful event.
Article contributed by The HARD Right Edge, which presents highly original workshops, tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission, which presents highly original workshops, tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission.
 
 

 

 
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Last modified: April 02, 2001

Published By Tulips and Bears LLC