TD Line Cancellations

TD LINE CANCELLATIONS

If one is day trading, then these cancellations can be ignored. However, if a trader is a trend follower, then any one or all of these cancellations or exits can be introduced. Three cancellations to an upside breakout above a TD Supply Line exist. If any of these cancellations occur, then the breakout above the TD Line is invalidated.

1. If the price bar immediately following an upside qualified breakout opens below the breakout price level, then exit the trade once the market opens.
2. If the price bar immediately following the breakout bar opens below the close of the breakout price bar and then closes below the breakout price level, then exit the trade.
3. If the price bar immediately following the breakout bar fails to exceed the high of the breakout price bar upside, then exit the trade.

Conversely, three cancellations to a downside breakout below a TD Demand Line exist. If any of these cancellations occur, then the breakout below the TD Line is invalidated.

1. If the price bar immediately following a downside qualified breakout opens above the breakout price level, then exit the trade once the market opens.
2. If the price bar immediately following the breakout bar opens above the close of the breakout price bar and then closes above the breakout price level, then exit the trade.
3. If the price bar immediately following the breakout bar fails to exceed the low of the breakout price bar downside, then exit the trade.

TD Line Summary

As you can see, TD Lines are constructed objectively and are a great aid to trend followers who wish to be alerted to potential low-risk intrabar price-breakout trading opportunities. By introducing the trading qualifiers we mentioned earlier, a trader can distinguish between valid and invalid trendline breakouts. Although not perfect, this filtering process enables a trader to enter an intraday breakout instead of awaiting the closing price to confirm the trade. A preferred use of the TD Line breakout qualifiers for option trading is to trade against the market’s trend and only concentrate upon those breakouts which are disqualified. Once these trading opportunities are identified, a trader can select specific options related to the underlying security and further confirm the signals with the option-related rules and other indicators described throughout this book.

TD LINE GAP

TD Line Gap is a derivative of TD Lines which introduces a novel way of drawing trendlines. Just as it does with TD Lines, price activity has a way of respecting these trendlines. Their construction is simple and the interpretation is straightforward. In fact, the numerous qualifiers and conditions associated with TD Lines can be applied or ignored totally with TD Line Gap. This indicator has a special application to option trading, allowing a trader to enter the market just after the open and to remain in the trade throughout the trading day. It’s a form of trend following, but the entry is sufficiently early to allow participation throughout the trading day.

TD Line Gap is an indicator which constructs a TD Line from a TD Point and a subsequent price gap or price lap. A price gap is described as a low which is above the previous price bar’s high, or a high which is below the previous price bar’s low. A price lap, on the other hand, is described as a low which is above the previous price bar’s close but not greater than the previous price bar’s high, or a high which is below the previous price bar’s close but not less than the previous price bar’s low. The construction of TD Line Gap first requires the identification of the most recent TD Point Low or TD Point High and the low or the high of the most recent price gap or price lap following the TD Point Low or TD Point High. In other words, to draw an upward-sloping TD Line Gap line, one must connect the most recent TD Point Low to the low of the most recent price gap upside or price lap upside. Conversely, to draw a downward-sloping TD Line Gap line, one must connect the most recent TD Point High to the high of the most recent price gap downside or price lap downside. For purposes of this discussion of TD Line Gaps, we treat price gaps and price laps similarly; however, they can be separated into two groups if a trader prefers, TD Lines with gaps and TD Lines with laps.

As with trendlines and TD Lines, once a breakout of a TD Line Gap line occurs, a low-risk buying (call-buying) or selling (put-buying) opportunity is presented. In the case of an upside breakout of a downward-sloping TD Line Gap line, the current price bar’s open must be greater than the previous price bar’s close to justify entry. Alternatively, if the current price bar opens above the descending TD Line Gap line and then trades at least one additional tick higher, a low-risk entry point is defined. In either of these cases, an upside TD Line Gap breakout presents a low-risk buying (call-buying) opportunity. Conversely, in the case of a downside breakout of an upward-sloping TD Line Gap line, the current price bar’s open must be less than the previous price bar’s close to justify entry. Alternatively, if the current price bar opens below the ascending TD Line Gap line and then trades at least one additional tick lower, a low-risk entry point is defined. In either of these cases, a downside TD Line Gap breakout presents a low-risk selling (put-buying) opportunity.

Figures 7.11 and 7.12 demonstrate the ease of TD Line Gap construction, as well as its interpretation. Figure 7.11 illustrates three TD Line Gap trades for the S&P March 1999 future. In each instance, entry at the opening upon exceeding the TD Line Gap produced large intraday profits. Each of these three trades worked on a closing basis, and even followed through the next trading day. By evaluating his or her position prior to the close, a day trader may have chosen to remain in the trade, thereby realizing a greater profit. Also, had a trader elected to day trade options rather than the future, larger intraday returns should have been realized due to the fact that options are highly leveraged. Figure 7.12 of Intel (INTC) displays three TD Line Gaps—two up-sloping (demand lines) and one down-sloping (supply line). In each instance, the opening price of the breakout price bar exceeded the TD Line Gap line in the direction of the breakout and then traded at least one tick further in the direction of the breakout, indicating a legitimate TD Line breakout. Each TD Line Gap low-risk entry level provided ideal option purchasing entry points and sizable profits, particularly the first and third occurrence. Had the more restrictive confirmation indicator TD Line Gap REBO (see following section) been installed, the entry levels would not have been as favorable, as a trader would need to await a breakout above or below both the TD Line Gap level and the TD REBO level. In these cases, if one were to use TD Line Gap REBO, an option trader would be forced to await a subsequent TD REBO indication rather than enter immediately following the opening price, since each TD Line Gap breakout occurred on the open.

TD LINE GAP REBO

Due to the high levels of market volatility over the recent years and the market’s tendency of forming a series of consecutive price gaps, creating numerous TD Line Gaps, we have added an additional element to perfect low-risk entries for TD Line Gaps. We refer to these enhanced TD Line Gap indications as TD Line Gap REBO, since we combine the critical TD REBO component to the TD Line Gap indicator. TD REBO is an indicator that identifies upside and downside levels at which market price momentum occurs. TD REBO is calculated by taking a percentage of the previous price bar’s true price range and adding that value to (for an upside move) or subtracted that value from (for a downside move) the current price bar’s opening price. When price breaks out above the upper TD REBO level, it indicates that further price movement to the upside should continue; when price breaks down below the lower TD REBO level, it indicates that further movement to the downside should continue. For TD Line Gap REBO, we typically use a modest percentage

Figure 7.11. The S&P March 1999 futures contract displays three instances where TD Line Gap occurred. In each instance, price broke out at the opening and produce a profitable return for an option day trader.

Figure 7.12. This chart illustrates three daily TD Line Gap trades for Intel. In each case, price exceeded the TD Lines Gap line on or just after the open and was immediately followed by favorable price moves.

factor for TD Line Gap REBO of 38.2 percent of the previous price bar’s true range. Chapter 9 discusses TD REBO and TD REBO Reverse in greater detail.

TD Line Gap REBO combines these two momentum indicators to confirm a TD Line Gap breakout. While this method is trend-following in nature and therefore occasionally results in delayed market entries, it serves to confirm the breakout. In order to obtain a low-risk entry point for TD Line Gap REBO, the market must exceed not only the TD Line Gap level, but also the TD REBO level in the same direction. Therefore, in the case of a TD Line Gap REBO upside breakout, the current bar’s opening price must be greater than the previous price bar’s close, and then price must exceed to the upside both the downward-sloping TD Line Gap line and the higher TD REBO level. In other words, for an upside TD Line Gap breakout indication to be given, we require that not only the open be greater than the prior price bar’s close, but that price advances above the TD Line Gap line and the TD REBO upside level as well. When price exceeds not only the TD Line Gap line to the upside but also the TD REBO level upside as well, it indicates that price momentum is positive and presents a low-risk buying (call-buying) opportunity. Conversely, in the case of a TD Line Gap REBO downside breakout, the current bar’s opening price must be less than the previous price bar’s close, and then price must exceed to the downside both the upward-sloping TD Line Gap line and the lower TD REBO level. In other words, for a downside TD Line Gap breakout indication to be given, we require that not only the open be less than the prior price bar’s close, but that price declines below the TD Line Gap line and the TD REBO downside level as well. When price exceeds not only the TD Line Gap line to the downside but also the TD REBO level downside as well, it indicates that price momentum is negative and presents a low-risk selling (put-buying) opportunity.

The following charts demonstrate both TD Line Gap and TD Line Gap REBO. Figure 7.13 shows the TD Line Gap trades for EBAY. Note that significant intraday profits were achieved and the performance would have been further enhanced in each instance by day trading options. By adding the REBO filter, entries would once again not have been as ideal, but would have produced profits as well. Figure 7.14 of Treasury Bonds March 1999 includes three TD Line Gaps. In each instance, the breakout openings which exceeded the TD Line Gap lines were precursors to profitable intraday trades. By adding REBO requirements to the entry, the trades become less profitable, but safer, since REBO serves as an additional confirmation qualifier which ensures a legitimate breakout.