Events and Signals

Events are points at which a number of conditions have come together indicating the occurrence of a high probability entry point. TrendLine Dynamics software currently identifies four kinds of high probability entries for security purchases. They are listed in order of their probability of signaling a profitable trade.

• L1 – Bounce off Confirmed Lower Trendline in Rising Channel
• L2 – Bounce off New Lower Trendline in Rising Channel
• L3 – Price Rising from Oversold Within a Rising Channel
• L4 – Price Making New High

We will discuss these four events in detail, examining the pros and cons of each one. Here are the definitions of key terms used in the descriptions. They are listed in alphabetical order.

Bounce

occurs when price touches a trendline and reverses direction — i.e., price hits the trendline and fails to cross it. In other words, it does not close on the other side of it.

Break

occurs when price encounters an established trendline and crosses it (closes on the other side of it).

Collimation

refers to how close to parallel the upper and lower trendlines are in a channel. If the upper and lower trendlines are parallel or nearly parallel, then the channel is said to have good collimation.

Confirmed trendline

means a trendline which has three or more touch points.

High trendline

is a straight line connecting (drawn through) two or more price peaks with no intervening prices that are higher than the trendline.

Low trendline

is a straight line connecting (drawn through) two or more price low points with no intervening prices that are lower than the trendline.

New high

occurs when a stocks price reaches a higher price than it has achieved during the last 52 weeks.

New trendline

is a trendline with only two touch points.

Oversold

refers to the condition created when a security or market goes through a rapid decline. If the decline stops without moving price a significant amount and price starts back up, then there is a strong chance that the supply (people wanting to sell in that price range) has been exhausted.

Touch point

is another name for a bounce. It is a location where price meets a trendline but does not cross it (close on the other side of it).

L1 – Bounce off Confirmed Lower Trendline in Rising Channel

When price bounces off a confirmed lower trendline, it shows that the trendline is still viable. It also indicates that there is a good chance that price will advance far enough to provide a profitable trade. Here is an L1 signal on GE on 24-April-2013:

The small black box on the trendline marks the bounce. The green diamond marks the signal date. The signal date may come several days after the bounce because the green diamond doesn't come on until one of the supporting indicators confirms the turn. By checking the accompanying channel chart we see that the channel has 3 touch points in the lower trendline and in the upper trendline, which means it is quite strong.

A conservative approach in this kind of situation is to wait for confirmation from the MACD (Moving Average Convergence/Divergence indicator – discussed more a bit later). However, if price declines rapidly it often turns up while the MACD is still headed downward. In this case, the MACD did not provide confirmation until April 29th. Entering on the 29th still would have provided a profitable trade, but even without MACD confirmation, the strength of the channel (both trendlines have 3 touch points) supports the credibility of the entry signal on the 24th.

Price bouncing off a confirmed lower trendline in a rising channel is the highest probability long signal, but it is always a good idea to check the other charts for confirmation.

L2 – Bounce off New Lower Trendline

While an L1 signal is generated by the third (or greater) touch point on the lower trendline, the L2 signal is triggered by the second touch point. In other words, the L1 signal comes from a bounce off an established trendline and the L2 signal comes from a bounce off a trendline that has just been identified.

This signal is an L2 because the only two touch points for the lower trendline are 12-Jul-2012 and 15-Nov-2012. Both the high and low trendline are rising. Additionally, the other channels for MMM are also rising. Further support for this signal is that the Smooth RSI was recently under 20, and both the Smooth RSI and the MACD have confirmed the entry. Good collimation also added to the credibility of this signal.

L3 – Price Rising from Oversold Within Rising Channel

When price moves down rapidly enough to become oversold and then reverses within a rising channel, there is a good chance that it will then will advance far enough to provide a profitable trade. This is true even if it has not reached the lower trendline of the channel.

L4 – Price Making New High

When price advances to a higher level than it has reached during the previous 52-weeks, there is a good chance that it will continue to advance. Here is an example of GS making a new high:

This is an example of a very good new high situation because the new high is occurring at the same time as other favorable conditions. Looking at the adjoining channel chart we see two things:

First, the new high is supported by a rising channel. (A new high without an accompanying rising channel is rare but it does happen.)

The second favorable condition is that price has just broken through the upper trendline of the channel. The high trendline in a channel can represent resistance to the continued advance of price; however, since price has broken through the upper trendline, we know that this will not be a problem in this case. (Four days earlier price made a new high, but that high was also a touch point for the upper trendline. Notice that price pulled back a little before proceeding upward. That pullback might have presaged a downturn, just like the touch point in October did.)

Overall, the L4 signal is the fourth highest probability long signal. There should always be a rising channel or at least a rising low trendline underneath price to support this signal. Be cautious of an L4 signal if:

1. it is triggered by a price jump;
2. the hew high is just below a high trendline; or
3. the market as a whole is forming a top.

These conditions are discussed in the next section: "Evaluating Opportunities".