Construction principles and application of TD Supply Line
Further description of TD Lines trend indicator by Thomas DeMark
In the previous article, I described the principles of drawing TD Points and TD Trend Lines based on technical analysis tools, developed by Thomas DeMark, a famous financial analyst and trader. I also explained TD Demand (support) line qualification and how to make right choice of points for entering and exiting trades.
Today, I will describe TD supply (resistance) Line in more detail and explain how to identify right points to enter LONG trades. We will also study the cases when the market is moving contrary to our expectations and the trend line breakout turns out to be false. In such situations, you need to find out the way to close long positions. I will take the BTCUSD pair as an example.
First, let me remind you how TD Supply (resistance) lines are drawn according to Tom DeMark Technical analysis.
TD Lines by Thomas DeMark (continuation)
As we all know, DeMark’s approach operates with the most up-to-date data. The current price movement is more important than price dynamics for previous days. Therefore, the trend line should be plotted from right to left using the highs, closest to the right-hand side of the chart. I mark them A and B. We draw a line through these points from right to left. This is TD Supply (resistance) line.
A little bit of advice. To facilitate the search for extreme points I used the Bill Williams fractal indicator. It looks for a bar that is surrounded on both sides by bars that have a closing / opening price lower / higher than its value and marks it with a tick. You can calculate the level of each TD Point using the measuring tool, which is located on the left panel in the tradingview panel and marked with a ruler icon, as shown in the figure below.
TD Supply (resistance) Line qualifiers
Analyzing a downtrend, traders always look for LONG entries. To do it you need to expect a signal of trend upside reversal. According to Thomas DeMark, this signal is a true breakout of the resistance line. Remember, the breakout is true if it is confirmed by on of the TD supply line qualifiers.
TD Supply Line Qualifier №1
Supposing that the price bar, breaking out TD supply Line upside, is bar X, you need to compare the closing price X-1 (the price bar prior to an upside breakout) with the closing price X-2 (the close two bars ago).
If close price X-1 is lower than close price X-2, then, in case of TD supply line breakout, bar X is likely to be the true reversal signal (see the figure below).
The logic is based on the assumption that if the lower close is before TD supply line breakout, forex market participants are likely to expect the downward momentum to develop and the sellers’ pressure to continue in the near future. Therefore, when there is an unexpected upside breakout, bears have to exit short trades, and bulls are likely to enter new long trades, thereby making the bar more likely to close above TD supply line. And vice versa, if X-1 closes higher than X-2 before the uptrend of TD supply line breakout, this intrabar breakout is less likely to be supported, because short-term traders will be positioned for a downward movement, expecting a further decline in the price. In practice, this means that if the price slides down and closes the bar before the breakout of the upper TD supply line, you can buy at the TD supply line breakout, expecting the bar to close higher than the breakout point.
If you see that the bar closes higher than the previous one, prior to the TD supply line breakout, you may consider this signal to be false, expecting the market price to close lower than this level.
In the above example, bar X-1 closes at 3438 and Х-2 – at 3451. As you see, in this case the first TD line qualifying condition is staisfied. So, the breakout is true and you may enter LONG trade higher than the breakout point at 3466 without expecting the close of bar X.
As you see from the chart, the trend has really reversed and the trade entered according to this signal could have yielded a good profit.
TD line qualifier №2
If the breakout bar opens with an upside gap and closes higher than Supply line, this indicates that that the new buying pressure has shifted the short-term supply / demand ratio in favor of the bulls. Thus, a TD line breakout will be considered true, and you may buy at the TD supply line breakout, expecting the market price to close above it.
Supposing that neither of the first two conditions is satisfied, you may apply one final qualifier to measure the pressure on the buyer, that is the demand, before the TD supply line breakout.
TD line breakout qualifier №4 is a supplementary, confirming signal and can’t be used alone.
As an example, I will build a TD supply line through two highs of the third level, A and B.
As you can see from the above example, the TD supply line breakout is at a level around 3911. Although the closing prices of the two previous bars are roughly equal and the condition of the first classifier is not met in this case, the TD line trendline breakout is true and the trend reversed upwards.
TD Line breakout qualifier №3
Supposing that TD supply line breakout is bar x, find out price bar X-1 prior to the breakout and calculate the difference between this bar close and the least of its two subsequent values:
- Low of this bar, or
- Closing price of the prior bar (X-2 close)
Next, add this value to the close price of X-1 and, if the result of the calculation is lower than the TD supply line, then buy on the intrabar breakout of the TD supply line, expecting the market to close above it.
If the result of the calculation is above the TD line breakout point,
Then the breakout inside the bar is considered to be false, and it is less likely to reach the lower limit at the close.
I will explain it on the example, displayed in the figure below.
X-1 low is 8953, the prior bar X-2 close price is 9060. I will take the X-1 low for calculation as it is higher than X-2 close.
X-1 close price is 9242
9242-8953=289 - This is the desired difference of the first stage of calculation.
We add this value to the closing price of the X-1bar and we get 9242 + 289 = 9531.
The TD-line breakout point in the given example is at 9398.
As you see, the calculation result is higher than the TD supply line breakout, so, if bar X in this conditions breaks through the supply line, it will be a true breakout.
In fact, if you look at the further price action, you will see that the trade, entered according to this signal, would have yielded a profit. However, the trend didn’t reverse, which proves the necessity of observing risk management rules and applying other technical tools.
Calculation of target profit for the TD supply (resistance) line breakout
Well, now you know how to identify right situation for entering trades on the TD supply line breakout. But this is not enough. To make a profit, you need to exit the trade at the right time, i.e. to identify the target profit to exit the trade. To set this target with a true TD line breakout you need to do the following:
1. Identify the lowest true low below the TD supply line and draw a perpendicular leg to the corresponding TD Supply Line above it.
2. Add the value of the perpendicular leg to the true TD breakout point.
The target won’t change until there is a true downside breakout. In this case the supply/demand trend will be shifted or the uptrend breakout target won’t be reached.
Let us verify this rule on the example.
As it is clear from the chart, the lowest price, prior to the breakout is 8774.
1. The distance from the low to TD supply line is AB leg. Its length is 9497-8774=723 points.
2. We add this value to the TD line breakout point and we will identify the target to exit the trade.
All these manipulations can be done directly on the chart without calculations. To do this, you need to draw a leg AB and copy it from the breakout point, as a leg CD (see the chart above).
Unfortunately, the market is not always moving as we expect it to. You should always take into account fundamental factors, affecting the price movements. In this example, the price went up to only level 10019 and started rolling down. This is 80 points lower than we had expected. This also occurs and you should bear such situations in mind.
TD supply lines and exiting a long trade
When we have entered a long trade, following a true intrabar upside breakout of the TD supply line, we need to know how to exit this trade if something went wrong, like in the previous example.
There are three ways to exit a long trade after a failed upside breakout of the TD Supply line.
- If the bar, following the upside breakout, opens at a price lower than the breakout of TD supply line, you should exit it at the opening price of this bar.
- If the bar, following the upside breakout, opens at a price lower than TD supply line and the bar close is lower than the level of TD line breakout, exit at the closing price.
- If the high of the bar, following the TD supply line breakout, can’t fix the price higher than the high of the bar at the moment of the breakout, you should exit at the closing price of this bar.
This objective approach to the trendline construction proves that you can eliminate subjective errors while taking decisions. Applying defining rules to identifying TD demand points and TD supply points, determining whether breakouts are true or false, and having a clear methodology for defining the target profits of a TD Line breakouts, should help you identify the market trend and improve your trading performance.
In addition, since this approach allows you to operate mainly in an intrabar way before the trade session closes, it can it may, in some time, reduce the slippage for trades. (By the way, some people apply trend lines to momentum oscillators. Based on the logic outlined for TD lines above, you can experiment with applying TD lines to other indicators of overbought/oversold (RSI), to identify true/false breakouts and to predict true breakouts. Since a momentum derives from the price, ideally, you would like to see the price trend line and the momentum leaving the overbought / oversold area at the same time.)
As you see from the given example, the TD supply line breakout is not confirmed in the RSI chart. In fact, the price having jumped up, is again going down. This means the trend is weak, which is proven by the further price movement in the chart. If the indicator had moved up into the oversold area, we could have state a strong bullish sentiment, but it is not about the example.
To consolidate the material on TD-Lines of supply and demand, let us study some more examples of analysis for the most popular cryptocurrency trading instruments.
Example of BTCUSD analysis
Let’s start with the BTCUSD pair. Just as Thomas DeMark recommended, we shall use the daily timeframe for analysis. Dots mark TD lines of supply and demand in the weekly timeframe, solid lines represent the daily timeframe.
I’ll also add the RSI indicator to identify the trend direction more accurately.
It is clear from the chart above that the price has broken through the TD support line but the conditions of the qualifiers are not satisfied, i.e. the signal is false.
Based on the RSI indicator, the price is moving towards the oversold zone. If we build the support and resistance lines in the RSI chart, we will see a Pennant pattern. The direction, it will be broken out, depends the further trend of the BTCUSD pair. Differently put, we make a conclusion that it is too early to enter a trade and take the investment decision. We need to wait.
Based on this chart, we can already assume that the movement to the zone of 3900 and lower has been a setup for the further upward movement of the BTCUSD pair, but there aren’t yet clear signals to enter a trade.
We deliberately ignore fundamental analysis, in order to demonstrate the efficiency of technical analysis, based on DeMark’s method.
Finally, the next price moves has proven our forecast.
It is clear from the figure above that the BTCUSD ticker broke through TD supply line only in a day. In addition, due to the first qualifier, the validity of the first breakout had been proven in advance.
With a more detailed analysis, it is clear from the above chart that, ahead the supply line breakout at the bar X point, X-1 close had been lower than X-2 close. In addition, the price broke through the triangle in the RSI chart, which became the confirmation that the future momentum is true.
That concludes the description of how to build TD Demand Line and TD Supply Line, well as how to analyze the market situation by means of a qualified breakout according to Thomas DeMark technical tool.
In conclusion, I can add that when you apply TD Lines, you should take into account the signals of Thomas DeMark’s other tools. TD-Lines is not am independent tool, it is rather a part of the single system of technical analysis that must be used together with other indicators and signals by Thomas DeMark. To revise the material, you can go back to the article about TD D-Wave, TD Sequential and TD Combo. This is not the full list of DeMark’s tools.
In my next articles, I will describe the technical analysis for corrections using DeMark’s tools. You will learn how to anticipate the depth and the duration of the corrective price movements, how to identify the price extremes and calculate the correction coefficient in any market and any timeframe. And of course, the final step of our study will be the joint application of these tools and the use of the single trading system by Thomas DeMark.
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