But today, I will include the questions AND answers right at the top of the article, because the stars happened to be aligned for 2 perfect examples to explain the answers to the two questions I had planned on posting below!
You'll see ...
TA Question 1: What is a "return trendline" or "return line"?
TA Question 2: When the prevailing trend is especially steep and the "return trendline" is penetrated, what is the most likely outcome?
TA Answer 1: "The Return Line" is the line in a "trend channel" that is parallel to the trend line.
When drawing a "trend channel", the first step is to create the "trendline" by connecting higher lows (in an up trend) or lower highs (in a down trend). The next step is to create a parallel line called "the return line", connecting the higher highs (in an up trend) or lower lows (in a down trend). Creating a return line is only possible on certain trends (not all).
TA Answer 2: If the trend is especially steep and the return line is penetrated, odds are that there will be an exhaustion followed by a consolidation. If the trend is not steep, it's more likely the trend will, instead, accelerate as opposed to consolidate.
But the question was: "If the trend is especially steep..." It's always important to confirm price action before acting on it. If a return line is penetrated, pay attention to see if the return line, which used to act as resistance (up trend) or support (down trend), becomes the new support (up trend) or resistance (down trend).
If, on the off chance a steep return line is penetrated and then successfully tested, the trend will likely accelerate even further. But as soon as you see the stock, ETF, etc., cross back below (up trend) or above (down trend) the return line, you'll know it's extremely likely that consolidation will follow.
Here's why the stars are aligned today ...
The last two trades closed out by our options experts, ex-Philly exchange options market makers Costas Bocelli and Ed Pawelec, offer perfect examples of two different -- but similar -- scenarios. (This isn't some marketing bit -- both of their services are closed to new members.)
The Acceleration vs. Exhaustion-Consolidation
Just one hour ago, Costas Bocelli closed out a spread trade that netted his Profit Skimmer members a 38% return in 9 trading days. That's the second win in as many weeks. Congrats, Profit Skimmers!
There were many reasons for him entering the trade, but in our weekly research meetings when he told me about Joy Global (Symbol: JOYG), there was one thing he was looking at that stuck out in my mind: The channel breakout.
Let's start with the long-term chart below for an example of an acceleration as well as a potential exhaustion. Back in early 2009, you can see there was a very steep channel where the red return line was penetrated. As is usually the case with a steep channel, this was followed by a move lower and a consolidation for about 6 weeks before the next move higher.
The next channel to the right lasted for about 1 year. Costas saw that the return line was penetrated, and the stock really got him excited after it was successfully tested (blue arrow).
Let's zoom in ...
I redrew the return line to show that an even higher version was also penetrated. You can see that THIS return line became more and more significant as it was tested (red arrows). Now, if this were a very steep return line, a penetration might have more likely meant exhaustion. But since it wasn't that steep, the breakout and confirmation meant it was time to act on the accelerating up trend.
SIDE NOTE: You can also see a channel within the channel from May to early September. That breakout also resulted in an accelerated up trend that eventually consolidated when it hit the major return line above.
Today, Costas saw his chance to skim that 38% profit when the new, very small but steep channel (blue and red lines) was penetrated. This looks more like a potential exhaustion!
Will it be? We will soon find out. Whether the stock declines or advances from here isn't the point. The point is what the odds favored, and when we trade based on what the odds favor, we make money over the long haul. We miss some, of course ... if you view a 38% profit that may have moved higher as "missing" some. But when the odds gradually tip the balance of the scale, we are able to see it happen and we can act!
Nice job, Profit Skimmers!
Right Said Ed!
I said the stars are aligned today, so I want to also show what Ed Pawelec just did.
He, too, made a fast 30% profit in 9 days! Look at the chart of WLT below.
You can see that, once the green channel -- a channel that wasn't very steep -- saw the return line penetrated, the stock's up trend accelerated. BOOM! A breakout from the horizontal resistance (black line) occurred on heavy volume. Ed put his "Price Shock" traders in, and a price shock they rode!
SIDE NOTE: Notice the channel within the channel (thin green within thick green lines).
The very steep channel was now in play (blue lines). When we have a steep channel with a return line penetrated, what is most likely going to happen?
So he exited the thing, because although it does happen, stocks usually don't trade straight up. WLT will likely consolidate its gains before moving higher, and the calculated risk told Ed to get his guys 'n gals the heck outta Dodge.
Good job, Price Shock Traders.
So that's it. I hope you can use this to avoid letting profits slip away, and I hope it helps you recognize and get into the channel break outs -- but the RIGHT channel breakouts -- and recognize the exhaustions!
Until next Tuesday!
Chief Investment Officer
Technical Analysis Millionaire