# Lesson 5 – How To Use Trendlines For Trading

## Pullbacks – John Hill’s Trend Line Theory

Trend lines, one of the trading tools, are the most amazing thing used by successful traders. Traders who avoid indicators also are favorite users of trend lines. Experienced traders can easily assess the way trend lines interact with price action even without drawing them. John Hills’s Trend Line theory will explain how you can join with those traders.

Ultimate Trading Guide is one of the best trading books co-authored by John Hill. This book contains the Yum-Yum Continuation Pattern, which I reviewed. Another not so popular book of john hill is ‘Scientific Interpretation of Bar Charts’. A chapter is devoted specially for his ‘Trend Line Theory’ in this book.

In this chapter, John Hill has introduced different types of trend line breakout setups. The purpose of these breakout setups is to find out the validity of these break out suing the following:

• Trend
• Swing retracement percentage
• Number of pullback swings
• Relative swing length

### TREND LINES AND PULLBACKS

This review contains the use of trend lines so that it helps to find pullback trades that are found in Trend Line Theory.

Usually, when a pullback is weak, traders will assume the trend will resume.Hence, risking of the valuable trading capital is worthy for a weak pullback. At the same time, strong pullbacks are clues for the very fast reversing market. Traders using pullbacks must hold the reins intelligently.

Complex pullbacks and their strengths are observed by the two simple trend lines.

## RULES OF TRADING FROM TREND LINE THEORY (PULLBACK)

Initially, you have to learn the way to draw the 0-2 and 0-4 lines. In a bull trend, point 0 is considered as the extreme high of a trend. Downward pullback begins from that point onwards.

• Start labeling from points 0 to 4 by referring the diagram mentioned below.
• Afterwards, if you connect points from 0 to 2, you will get your 0-2 line, which is green.
• Finally, if you connect the points from 0 to 4 you will get your 0-4 line, which is red.

The focus point is the relative slope of two lines

The pullback is powerful when the 0-4 line is steeper and hence you must avoid trading this.

The pullback is weak when the 0-2 line is steeper and hence you must consider trading this.

These are examples for bullish market and the same logic can be applied to bearish market. You can very well practice drawing equivalent diagram of a bearish trend for an exercise and verify your final conclusion against trading rules mentioned below.

1. Bull trend
2. 0-4 line is higher than 0-2 line
3. Buy on bullish breakout of 0-4 line

1. Bear trend
2. 0-4 line is lower than 0-2 line
3. Sell on bearish breakout of 0-4 line

You may find this setup a little confusing initially. Just concentrate on the 0-4 line.

• In a bull trend, the 0-4 line should be higher for a long pullback trade.
• In a bear trend, the 0-4 line should be lower for a short pullback trade.

## EXAMPLES OF TRADING – TREND LINE THEORY (PULLBACK)

It is very much suitable for an intermediate indicator period in order to trade deeper pullbacks. So, this example 50-period SMA (the orange one) is used to check the trend.

Price swings are marked in Blue so that anchors and their trend lines are highlighted.

#### McDonald’s Corporation (MCD) – A daily chart.

1. From the above diagram, you can see that MCD is trending downwards since it is below its 50 period SMA.
2. Then note that price has started towards upward pullback. You can see the consecutive bull bars in the second leg up, four in number,which is clearly a sign of strength.
3. With the trend line analysis you can arrive at a different conclusion. Even though there is upward thrust, the bears are increasing in its strength and the 0-4 lower line. In addition, resistance from SMA has added up to the situation. Hence, as the price break down below 0-4 line, it is wise to sell.

You can find that the short position is profitable and the MCD is continuously in the downwards trend.

#### Exxon Mobil Corporation (XOM) – Daily Chart

1. A pullback to 50-period EMA happens when XOM experiences free fall
2. As a result, many strong bullish trend bars along with a great momentum are displayed by this pullback. In addition, earlier bear swings are cancelled due to this pullback.
3. As the 0-2 line is above the 0-4 line, the 0-2 line break the 0-4 line and the market experienced a short entry.
4. After some time the prices drifted upwards instead of falling downwards.

This is an example of losing position. There is the clear warning given by the deep retracement of the pullback. Keep in mind that deep pullbacks may turn out to be a reversal in disguise.

This strategy impresses me a lot since this is the cleverest way of utilizing trend lines. In order to enjoy a reliable pullback setup, you need to concentrate on the trend context.

This setup of trend line usage does more than judging the simple breakouts or the market bias. The combination of two [0-2 and 0-4] trend lines makes it easy to judge the pullback strength.

Swing pivots are part of trend lines on which they hang on. Swing pivots and the different methods of marking them affect the slope of the resulting rend lines. This is because of the confusion in marking them.

Take the above example where I have used only basic pivots. Whatever method you use to mark the points, you must stick on with that all through you’re trading.

Among these various methods, waiting for a definite trend line break is the safe entry method. This means you need to wait till the bar gets close above or below the trend line. However, this method has a risk factor. You may miss the profitable and swift breaks.

On the whole, ‘Scientific Interpretation of bar Charts’ by John Hill contains lots of complex ideas regarding price action. It must be studied in detail by all price action traders.