Understanding Trend Lines in E-Mini Trading: Types and Angles

I make it point to sketch in a trendline on the e-mini charts I trade. I don't use the automated trendline programs that have become very popular of late. No, I prefer to draw my trend lines manually using the tops of each bar range, as oppose to drawing trend lines based upon the close of each bar.

I feel I get a better understanding of the e-mini chart price movement when I employ a manual method for drawing lines; or maybe I have been drawing them in this fashion for so long that it is force of habit. Either way: I draw my lines by hand.

Trend lines can be classified in two distinct categories:

1. External Trend lines: External lines are, by far, the most common line most traders employ. The technique for drawing this flavor of e-mini trendline is similar to playing "connect the dots." When drawing an up sloping trend line, a trader will connect the valleys of a rising trend. Of course, when the price action violates, or passes through the line, the potential for a trade arises. Down sloping trend lines are draw in exactly the opposite fashion of up sloping line. A down sloping line connects the price peaks. The reason these lines are drawn, either up or down, is to get an idea of when a potential price change may occur.
2. Internal trend lines are a bit more esoteric and are generally not used by the average retail trader. Internal trend lines are drawn so that they rest on the flat peaks or valleys and they are known to pierce through existing price action. Analyst generally argue that internal e-mini trend lines represent the buying and selling behavior of the masses, while external lines represent the behavior of active e-mini traders who tend to trade at the extremes.

As I mentioned, most trend lines you will see will be of the external variety, with the internal lines used most by technical analysts.

These days, once a trendline is drawn, most traders are concerned with the direction of the line. Is it moving up or down? They are generally concerned with determining the direction of the trend.

Have you ever given any consideration of the angle of the line? You should; because the angle of a line can give you valuable information about what you can expect when you encounter a trendline violation.

For example, the steeper the trendline in a breakout, the poorer the performance in terms of potential gain. This research by Thomas Bulkowski shows empirically that a breakout angle of 30 to 45 degrees travelled the furthest to the upside or the downside, depending on whether the departure is a breakout or breakdown. On the other hand, break outs with a slope angle of 60 degrees or more tended to travel the least amount of distance. The conclusion? Departures from a trendline that were between 30 and 45 degree tended put the most money in a traders pocket, and sharp departures of 60 degrees or more tended put the least money in the traders pocket. Angle is important, yet it is seldom part of the trade consideration process of most e-mini traders. Why? They simply don't know the facts.

In summary, we have identified two distinct types of trend lines and defined each in a coherent manner. Further, we have discussed the angle of departure (relative to a horizontal line) of a breakout or breakdown and identified specific characteristics of each angle. We favor angle of departure in the 30 to 45 degree range, and understand that departure angles of 60 degrees or more tend to produce substandard results.