- 2001: Volume 10, No. 1 Following the Straight and Narrow: Day Trading SPDRs Using Trendlines

In the introduction to his book, Technical Analysis of the Futures Markets, John Murphy writes about his experimentation with various technical indicators. Murphy concludes, "in most cases, the simpler techniques seem to work best." This article takes that conclusion and applies it to the day trading of SPDRs using one of the simplest technical indicators, the trendline.

SPDRs, or Standard & Poors Depository Receipts, were first introduced by the American Stock Exchange in 1993. They trade intraday at one-tenth the S&P 500 index. For example, if the index is trading at 1290, SPDRs should trade at about . The major benefit of trading SPDRs as opposed to an index mutual fund is that because they trade intraday, they allow the day trader flexibility when daily market trends change.

There are no straight lines in nature. A counterpart to that might be "there are straight lines on price charts." And because there are, the trader has an almost ready-made system. Not a guaranteed-to-never-have-a-losing-trade system, but a system that, when accompanied by a few trading rules, is simple and effective.

Systems. That word, when applied to trading, can mean anything from algorithms to a two-day reversal pattern. But the one thing all systems need, if they are to be effective, are guidelines. The guidelines for the system presented here are: (1) all positions are closed out at the end of the day; (2) the trendline is traded on the third connected point; and (3) the stop loss is placed at a one-tick violation of the trendline.

The two charts below give examples of three successful trades and one trade that was stopped out. The charts are one-minute bar charts of the daily S&P 500 from December 28, 2000 and from January 2, 2001. After reviewing the charts and the strategy applied to them, the advanced trader may ask himself why this system cannot be used to trade the e-mini S&P futures contract or the full-size S&P contract. The answer is that it certainly can be used to trade those markets.

December 28, 2000
In this chart, we see a consolidation from the open until about 11:30. The series of descending tops from the peak at about 9:45 make this an ideal situation to look for a trendline to form. And with the third point being connected at about 11:30, a trade would then be put on. From that point the index forms a breakaway gap and eventually a runaway gap at about 11:50. (I leave it up to the individual trader to use his or her exit strategies when exiting a winning trade.)

The second opportunity to place a trade occurred during the upside move after the market formed a double bottom at 1326 at about 12:15. The market turned down at the third connected point and a moderate down move was underway.

The third opportunity to place a trade on this chart occurred during the continued uptrend from 12:15. The market, however, blew right past the third connected point, stopping the trade out. One clue that may have helped alert the trader that point three might fail is the runaway gap that occurred at about 3:15 once the market started to break down. It is rare that a trendline could hold that severe of a decline and it is one example of why very tight stops are used here.

Figure 1:

January 2, 2001
This chart illustrates that trendlines do not always have to be diagonal. This first trendline bounded the upside moves during the consolidation that took place from about 11:15 to about 1:30 at which time the index finally broke to the downside and continued down almost into the close.

The trading opportunity in this chart occurred at about 1:15 when the third point was touched. It is typical of congestion patterns that when price does break out, either up or down, it does so in an unmistakable thrust. Also of note is the second trendline, which contained the downtrend from 1:30 forward and acted as strong resistance during the entire down move.

By using trendlines to trade SPDRs the day trader has a simple, easy-to-follow indicator. And while not infallible, trendlines can help the trader develop an effective system that, with some practice and discipline, may help him or her turn what can be a frantic six hours and 30 minutes into a less problematic exercise.

Figure 2:

Jim Niendorff is an affiliate with the Chicago chapter of the Market Technicians Association. He is currently awaiting the acceptance of his CMT Level III research paper by the MTA. His interests in technical analysis include market psychology and sentiment.