Trend lines are a great tool, there are traders who have resisted indicators and swear to stay loyal to the trendline. The handful of seasoned traders can even see how prices react to the trendlines without drawing them. If you really love and want to dig deeper into this tool, then let's take a look at John Hill's trendline theory.

Talking about John Hill, he is the author of Ultimate trading guide, a very worth reading trading book. He is also the author of the Yum-Yum continuous price model, and a lesser-known book, Scientific Interpretation of Bar Charts, has a brief chapter on theory and trading style. The same trendline that this article would like to mention, the content includes:
  • Tendency;
  • Number of pullback tops/bottoms;
  • The relative length of a swing;
  • The return rate of a swing.
Trendline and pullback

In the scope of this article, we will learn how to use trend lines to identify pullbacks in a trend.

Basically, the weaker the pullback, the more likely the price to return to the previous trend. This means weak pullbacks are worthy times for a trader to risk capital, and on the contrary, strong pullbacks are a sign of a potential reversal.

With this theory, with just two simple trendlines, you can observe the complexity as well as the strength of a pullback.

John Hill trendline theory - pullback rules

The first thing to do is to define two lines: 0-2 and 0-4. In an uptrend, point 0 is the highest peak of the trend, which is where the pullback begins. See the illustration below:

  • First of all, it is necessary to define the bottom peaks from 0 to 4;
  • Connecting vertices 0 and 2 together we get the blue line (line 0-2);
  • Connect vertices 0 and 4 together, we get the red line (line 0-4).
We need to define these two lines as we will determine the strength of the pullback based on their slope.

If the 0-4 line is below the 0-2 line, the pullback is very powerful, the trader should not trade when the 0-4 line is broken.

If the 0-4 line is above the 0-2 line, the pullback is relatively weak, the ability to recover the trend is high, Trader should consider trading when the 0-4 line is broken.

For a bear market, we apply the same logic.

Buy order rules:
  • Increasing trend;
  • Line 0-4 is on line 0-2;
  • But when the 0-4 line is broken.
Sell order rules:
  • Downtrend;
  • Line 0-4 is below line 0-2;
  • Sell when the 0-4 line is broken.
If you feel confused, just keep in mind the rule below:
  • BUY in an UPTREND, when the 0-4 line is UP;
  • SELL on a DOWN TREND, when the 0-4 line is BELOW.