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Friday, May 18, 2007
TIP: Is Trendline Break Valid?
Bad signals, commonly called “whipsaws”, can be eliminated when a trader uses time and price filters to try and isolate valid trendline penetrations. Whether he is Day trading, Swing trading or Options trading, the trader knows the general rules is: a close beyond the trendline is more significant than an intraday penetration. The 3% penetration criteria is a price filter used mainly for the breaking of a long term trendline. The rule states the trendline must be broken, on a closing basis, by 3%. Keep in mind, this rule doesn’t apply to some markets, such as interest rate markets.
Let’s say some longer term traders, as in Swing or Options, were watching an uptrend on a trade of Google (GOOG). The price breaks the up trendline at $380 and closes 3% below the trendline at $368. While a $12 trendline penetration may be important to these traders, it wouldn’t be appropriate for Day trading. A 1% criterion is a better choice for this short term trading. The percent rule is just one form of price filtering. There is a tradeoff when using any type of price filter. If the filter is too small, it’s not useful in reducing “whipsaws”. If the filter is too big, then the initial move required to see a valid sign may be missed. A trader needs to decide which type of filter is best for degree of trend he is following, and to make allowances for the differences in markets.
If a trendline is broken by some predetermined price increment or percentage, the trader may decide to use a time filter instead of a price filter. The most common time filter is the 2 day rule. This means a valid breaking of a trendline would require that the the trade closes beyond the trendline for two successive days. Looking at an uptrend, the up trendline would need to close under the trendline two days in a row. In a downtrend, the prices would need to close above the trendline two days in a row.
The 2 day rule and the 1-3% rule may also be applied to important support and resistance levels as well as major trendlines.
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Let’s say some longer term traders, as in Swing or Options, were watching an uptrend on a trade of Google (GOOG). The price breaks the up trendline at $380 and closes 3% below the trendline at $368. While a $12 trendline penetration may be important to these traders, it wouldn’t be appropriate for Day trading. A 1% criterion is a better choice for this short term trading. The percent rule is just one form of price filtering. There is a tradeoff when using any type of price filter. If the filter is too small, it’s not useful in reducing “whipsaws”. If the filter is too big, then the initial move required to see a valid sign may be missed. A trader needs to decide which type of filter is best for degree of trend he is following, and to make allowances for the differences in markets.
If a trendline is broken by some predetermined price increment or percentage, the trader may decide to use a time filter instead of a price filter. The most common time filter is the 2 day rule. This means a valid breaking of a trendline would require that the the trade closes beyond the trendline for two successive days. Looking at an uptrend, the up trendline would need to close under the trendline two days in a row. In a downtrend, the prices would need to close above the trendline two days in a row.
The 2 day rule and the 1-3% rule may also be applied to important support and resistance levels as well as major trendlines.
Stop stressing from the guessing and learn from our experts.
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Call our Customer Service Department Now!
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Nick Fenton
VP of Operations, DaytradeTeam
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