From the August 01, 2007 issue of Futures Magazine • Subscribe!

Price-action lines on the E-mini

You learn a lot about what doesn’t work day-trading the S&P market for two decades, but luckily, if you don’t try to get too complex, you also can stumble upon a setup or two that work quite well. Once such technique is based on price action around easily identifiable support and resistance levels. Applied to a five-minute candle chart, it can identify reliable entry and exit points in E-mini S&P 500 futures.

At the heart of this strategy are price-action lines. This is a broad category of support and resistance identifiers that include trendlines, trend channel lines and regression lines.

This non systematic approach offers considerable flexibility for traders willing to take the time to learn its details and practice its application. This article will follow a typical trading day, broken down into a series of charts, to demonstrate how to use price-action lines for entries and exits.

BULL OR BEAR?

First, a bull or bear leg is identified with a trendline. For a bull leg, the trendline is drawn by connecting two significant lows with a straight line. This line is then usually extended up and to the right. For a bear leg, the trendline is drawn by connecting two significant highs.

Note that the trendline can be horizontal when drawn across the lows of a double bottom in a bull flag, for example.

The objective is to observe how the price acts on subsequent tests (touches, penetrations or approaches) of the trendline. In the case of a support line, if it bounces off the line, this is often a buy signal. If instead it collapses in a big range bar through the trendline and the bar closes near its low, the bull swing might be over.

However, this is generally unknown until more price action unfolds. It is possible that the market is creating a trend with a wider channel and a flatter slope. Such a scenario would require a new trendline and another period of observation.

Once it appears likely that the market is in a bull swing, start the trendline at the low of the bar that started the swing. For the second bar, look for the first bar that has a low below the low of the prior bar. This line becomes the first bull trendline drawn amid the new price action.

As time unfolds, this bull trendline should be redrawn. In most cases, each subsequent line typically has a flatter slope, but in a runaway bull swing, the trendlines can get steeper. It is common for there to be a higher low within a few bars of the start of the trend, and frequently you will have to switch to using this bar for the first bar of the bull trendline because it will result in a line with a flatter slope and will likely provide more reliable signals.

The first chart in “Getting started” (below) shows an example of a bull trendline drawn across the lows of bars “3” and “5” and then extended a few bars up and to the right until it is penetrated by bar “8.” As a visual aid, it is helpful to use a thick line between the two bars that provide the high or low points and a thin line to indicate where the line was extended to the right.

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