In our previous newsletter, we explored the 45-degree trendline on Point and Figure (PnF) charts, highlighting its effectiveness in objectively indicating a stock’s price trend. We noted that when the price is above the bullish 45-degree trendline, there are more Xs plotted than Os, and conversely, when the price is below the bearish 45-degree trendline, there are more Os plotted than Xs from the point where the trendline is drawn. When the price is near either trendline, the number of Xs is almost equal to the number of Os.

Using this concept, we developed a short-term trade setup known as the ABC setup. In today's newsletter, we will focus on leveraging the bearish 45-degree trendline to create a longer-term setup.

The Inspiration behind this setup

Let us discuss about two context around trendlines:

First, the 45-degree trendline is a very useful tool to understand the change in trend. When a bearish 45-degree trendline (that is plotted from the start of a downtrend) is breached, it shows that the price’s trend has changed from bearish to bullish because the number of X is now more than the number of O.

Second, the assumption in this observation is that the Indian markets are inherently bullish, and any bearish trend will be short lived. When seen from a long-term point of view, this would mean that the bigger trend of any stock is bullish, and a bearish trend is a slight correction. When a stock is in a bearish trend, it is reflecting the weak fundamentals and when the trend changes to bullish, it can be assumed that the management of the company is working towards making the fundamentals strong and hence the change in trend.

When we put these two context together, we can use bearish 45-degree trendline to understand when the short lived bearish trend has ended, and the longer-term bullish trend has resumed as a result of improving fundamentals of the company. To view this on a long-term basis, we use 1% (daily TF) chart of PnF. This is because 1% charts can capture a huge amount of price action and a breach of trendline on this box size is a significant information.

Factors that improve the accuracy of the setup

There are two important factors that affect the accuracy of the setup. These factors are important because they ensure the traders do not participate in false breach of trendline. These factors are:

1. Pattern Retest: As the name suggests, Pattern retest is when the price revisits a previous pivotal point and forms a similar natured pattern. That is, two or more bullish patterns at the same price range (in case of a bullish pattern retest) and two or more bearish patterns at the same price range (in case of a bearish pattern retest). This can be thought of as W and M patterns but with lot more significance because it is on PnF chart.

   Pattern retest is important because it shows that the price has entered into an accumulation phase after which, the price can move quickly.

   Pattern retest before a breach of bearish 45-degree trendline is a confirmation that there is a built up and the breach is not false.

2. Outperformance of the stock: Out performance has been the foundation of my trading philosophy. I have observed that when a stock starts its outperformance relative to a market benchmark such as Nifty 50, it can last for years.

   
   When the breach of trendline is followed by outperformance of the stock, it conveys that the breach was not only good but great because the probability of this setup has improved.

Setup to understand lifecycle of a stock:

Let us not put these separate components together. The rules for the setup are as follows:

1. 1% (Daily TF) chart of PnF

2. Breach of 45-degree trendline

3. Pattern retest before breach of trendline

4. Out performance of the trendline after the breach.

Observe the chart below of INDIANB. The red box shows the pattern retest and the accumulation phase of the stock. Observe how much the price moved after the breach of the trendline. At the same time, the Relative strength charts also showed the outperformance of the stock.

Observe the chart below of GODREJPROP. The red box shows the price accumulated for more than a year and when the price broke the trendline, it resumed a bullish trend that surpassed the previous high as well.

The whole idea behind this newsletter was to share my observation on the lifecycle of a stock. I call this as lifecycle of a stock because the price goes through the cycle of bullish trend to bearish trend to bullish trend and so on………

The study of the 'Lifecycle of a Stock' stems from years of observing PnF charts. In addition, I have developed various strategies using other charting methods, such as candlesticks and Renko charts. These strategies, along with the concepts behind them, have been structured into a comprehensive journey designed to help traders enhance their skills and gain new insights into technical analysis. If you're interested in learning more, you can access these courses by subscribing to TNT One, which provides access to all my current and future courses.

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