Before turning to examine what this
trading strategy involves, let's take a moment right at the
start to drive home an important point about trend lines.
The point is simply this: you need to have extraordinary
patience and persistence while working them. Why? Because
trend lines need to be adjusted every so often. This can
happen for a variety of reasons.
Here is one reason:
stock chart with trend line.
This chart represents a stock in a clear downward trend.
Prices nicely touch the trend line in four places, which
lends confidence that the line also acts as a resistance
line. That is to say, prices appear to have trouble
breaking above this line.
However, on Jan. 27, it does just that:
DVA stock chart
with trend line broken upward.
The initial price breach is slight. And the next day it
seems prices resume their previous pattern, remaining
wholly below the trend line and with the day's high just
touching that line.
The following days are a different story. For two
consecutive trading sessions prices remain above the
line. At this point, the break of the trend line becomes
Yet by Feb. 2, prices seem to be declining again
The question to ask is: given this chart, should the
trend line now be redrawn?
According to the method
of drawing trend lines recommended on this site,
the answer is no. A trend line should always touch its
final point somewhere prior
to the lowest low. This condition would not be
satisfied if you were to pivot the line upward to the
high point on Feb. 1, since the lowest low point comes
before this day, on Jan. 20. So unless the particular
trading strategy you are using calls for taking a
position at this time (possibly going long because of
the resistance line breach), you would need to take a
wait-and-see approach to this particular stock.
But you would not have to wait long. Because on the
following day, prices make a new lowest low:
DVA stock chart
with a newly drawn trend line.
With a new lowest low on Feb. 8, the trend line would
definitely need to be redrawn. This is because the old trend
line would intersect prices between its first and last
connecting points and this is forbidden in properly drawn
trend lines. The newly drawn trend line would remain valid as
prices subsequently make even lower lows on Feb. 9 and 12. At
this point, you would need to wait and see if the line qua resistance will
continue to hold back prices, as
it has apparently done on the last day shown on the chart,
and for how long.
So what's the strategy?
that you have an idea of the need to stay vigilant with your
trend lines, let's see what the 'Short on 4' trading strategy
is all about.
As implied above, you are hardly ever lucky enough to get
clear indications of a change in trend. A stock will not trend
upward along its support line, to then break out of that
support line and turn into a downtrend with a tidy resistance
line, all that often. Far more often the price will wander
around a bit, perhaps testing the last high. This can be quite
annoying, especially if you sold at the break of support.
(For this reason, you should also understand that when charts
are used to teach trading principles and to illustrate trading
techniques and strategies, they are just that: heuristic
devices. They should be selected to just get the point across
and nothing more. They shouldn't give off the impression that
all stocks behave in that way. So be wary of sites that only
use charts, particularly artificial ones, where all the
elements fall into line and seamlessly jibe with what the text
is talking about. Reality is not that neat and tidy. It is
always better to learn directly from what the real markets
have to teach, rather than from the ideals technical analysts
set for them.)
Consider the following chart:
BG stock chart with sell short signal on break of minor
low price level.
The first major event in this chart is the break of the
support line. But instead of seeing a sustained inverted
V-shaped down move right after, the price goes on to test both
the highest high, and a significant minor low point which
occurred during the previous upward trend. It is only when
prices cross under this previous minor low point that you can
be fairly certain that the move is over and a new trend is in
To reiterate in step-like fashion, here is what to look for
when an uptrend changes into a downtrend:
break the support line downward.
test (possibly repeatedly) a significant minor low point
formed during the uptrend.
test (possibly repeatedly) the highest high of the
break the price level established by the significant minor
that steps (2) and (3) could occur in reverse order. The
important thing is that prices appear 'caught' between the two
levels established by the highest high and the significant
minor low. It then becomes a major event when prices break
downward through the lower price level.
According to the short on 4
strategy, you are to sell short once step (4) has
Not every break of support follows this exact pattern. But it
is a useful model to learn, not least because it reminds us
that trends hardly ever end and reverse direction in one
speaking, the set-up to this trading strategy is called the
pullback. Pullbacks are one of the most irksome and vexing
phenomena in technical analysis. They are also alternatively
called retracements or corrections. In other contexts, these
latter terms have different meanings. But pullback has fewer
A central characteristic of the pullback is a roughly sideways
movement that occurs after a trend line breakout. Quite often,
it occurs just before it as well. The pullback is symptomatic
of congestion – a term aptly describing market traders milling
around like holiday shoppers in a crowded mall trying to dodge
one another, but who only succeed in impeding the general
progress of everyone involved. Still another term for such a
sideways price movement is consolidation, which refers to
market traders consolidating their ideas about the particular
financial instrument being traded. Often, consolidation
precedes a breakout of the trend line.
Essentially, congestion and consolidation describe the same
market phenomenon: trendless prices trading within a definable
range, as in the case above where stock BG bounced between a
previous high and low for around 23 trading
sessions (or just over a month). Consolidations not only
precede a breakout. But they also often follow a breakout.
Here's a trading tip: if you observe a sideways price
movement, but can't identify the trend, zoom your chart out so
that it covers a longer time frame (eg,
switch from a daily to a weekly chart). Odds are that either a
breakout has just happened, or one is just around the corner.
More on Support and Resistance Lines
the trader understands the concepts of support and resistance
and begins to use them in his technical analysis, the lines
themselves become the focus of attention rather than the
trend. Traders make decisions to buy and sell because of what
happens to the line, often times without anything really
happening with the underlying trend.
Support and resistance is quite well-known to today's trader.
These lines occur so frequently on their charts that they have
largely become a self-fulfilling prophecy. Many traders draw
and trade according to the same lines. On the one hand, owners
want to defend the price because they want to see the price of
their shares survive the test of support and thereby encourage
additional buyers to bid up the price to higher levels.
On the other hand, potential buyers want the price to fall so
they can purchase the stock more cheaply, or to cover their
short positions. The professionals in the market usually know
where the amateurs have placed their buy and sell orders. As
amateurs, they often place these orders at round numbers and
other obvious support and resistance levels. The former group
can then easily pick off the latter for a quick buck. The
professionals can and will push the price under a support line
just enough to scare the amateurs into selling. But knowing
these games is not enough to completely avoid all the negative
consequences. For instance, if you don't place your order at
an obvious support or resistance level because you no longer
want to be a sucker, you might very well miss an entry or exit
at the best price.
So it's not enough to simply draw good and valid trend lines
to maximize your profitability. You also need to study how
often traders of your particular financial instrument spook at
resistance levels, or break support by just a hair only to bid
the price up afterward. In the end, it's not the line that
counts, but the psychology of those folks who created the