Reading the tape is one of the essential indicators when active trading.  Many traders know about the hundreds of indicators readily available on most trading platforms, but very few have an idea of how to read and interpret the tape.  Interpret is really the best way of describing how you need to approach your relationship with the time and sales window.  Unlike other indicators which have oversold or overbought levels, reading the tape is specific to each situation.  This goes beyond how a stock trades, but how a stock is trading on a given day and at a given price level (e.g. 10, 25, 100).  In this article we will cover the basics of the time and sales window and tape reading (speed of the tape, size of orders, etc.).  The tape is most important when validating breakouts and supply vs. demand at critical price points.  Once you have given this a thorough read, I highly advise you review the following related articles:  (1) Psychological Support and Resistance Levels, (2) Day Trading Time Zones, and (3) Day Trading Breakouts.  In each of the aforementioned articles, you will see how the tape provides validation to the price action, which will prevent the dreaded scenario we’ve all faced of being caught in the “trap”.  Lastly, regarding tape reading, it truly requires the “gift of touch”.  For those unfamiliar with this term, it basically means you do or use something so much, you begin to gain a sixth sense of when things are about to happen.

What is the Time and Sales Window?

From my experience in day trading over the last few years, my most valuable tool became the time and sales window, aka. the “Tape“. The time and sales window basically shows the trader detailed information regarding the order flow for a particular security. The time and sales window provides details on each of the trades that have gone through for that security, such as: Time of Trade, Price, Size of order, and condition of order. Depending on the trading platform, you will have other data points available to you.

After mastering the message of the tape, you will be able to accurately decide when to enter and exit a trade.

How to Use the Time and Sales Window

I am a very big believer that there are two truths in trading stocks. One is price and the other is volume. Tape reading involves both; and if used correctly, dramatically increases the odds of your trading working out. It does so due to the fact that your goal with tape reading is to follow the money. While some professional traders may not like to admit it, trading stocks is an odds game. Your job as a trader is to put trades on with the highest odds of winning. Trading with the tape requires trading with patience. You cannot go out and buy or short a stock because you see the tape speeding up a bit. You need to be aware of support and resistance levels and also combine the message of the tape with price pattern formations. Tape reading can be very fast and confusing at times and requires quite a bit of practice in order to get used to understanding the true meaning behind what you are seeing. Remember, every stock is a different story and tends to trade differently. It is wise to review the way in which the “tape” trades for a couple of minutes before entering a trade. Reading the tape requires you to train your eyes to scan for changes in character. I want to discuss a few of these key changes that you should take note of:

Size of Orders

Lets start with size. The size of the orders coming through will help you decide if there is conviction behind the price action you are seeing. When putting on a trade, you typically want to see a flurry of buy or sell orders which have greater than 300 to 400 shares in size. There is no hard and fast rule about this; it is more of a visual cue that your eye gets trained to recognize. Many times, I will see great technical setups in stocks that trade low volume. I stay away from these setups as the message of the tape is not as clear and this lowers my odds of a winning trade.

Order Speed

The speed of the orders is another key component to the message that the tape is giving you. Typically, when stocks breakout through support or resistance levels, not only will the size of the orders go higher but you will see the tape start to speed up. This gives you an indication that there is an interest in this stock at this level and that the interest is larger than a couple small traders buying or selling.

Order Condition

Order condition refers to which side of the bid/ask spread the trade was executed on. When we go long a stock, we want to see many orders being executed at ASK. Conversely, when we go short, we want to see orders being filled at BID. This gives us a clue as how desperate traders are to get into our out of this stock.

Speaking from Experience…

Above, I have reviewed a few basic principles of tape reading but I want to discuss some of lessons I have learned throughout my years of trading that I think you will find helpful when analyzing the tape.

Which stocks are best to trade?

I have received this question many times. The answer to this question for me is simple, I only trade the most volatile stocks of the day. These stocks are the ones which will provide you with strong volume and large interest from the public. They also provide strong and fast moves which you can make larger profits from. Remember, we need to see speed in the tape and that requires a stock with public interest.

Does the tape work better during specific times of the day?

In my experience, the answer to this question is YES. I typically only trade the first 2 hours of the day. This is when the most volatility is present in the market and also when most of the trending moves are made. Typically, lunchtime produces a choppy market and has a different group of traders who are buying or selling for different reasons than the first hour. I am not ruling out trading after lunchtime, however, my results have been less than stellar when I attempted to do so.

Tape Reading with Level 2

The level 2 window provides the trader with an edge. It will show you the sizes of the orders in the market makers book. While the market makers can play games with the level 2 in order to fool traders, in general you want to see high bid sizes and low ask sizes when you go long. On the flip side, you want to see low bid sizes and high ask sizes when you go short or sell out of a stock. Again, its not foolproof but it adds to the odds of your trading winning.

Exiting a trade

This is probably the most difficult part of the trade for most traders. Tape reading helps me get out of the trade by looking for imbalances. When I see a stock moving sharply in one direction, I will immediately look to the tape to offer clues as to when the brake pads will be applied. Again, this skill will take practice to develop. If your short a stock, keep an eye out for the bid side getting heavy and the bid/ask spread widening. This could be a tell tale sign that the juice has been used up.

Bid/Ask Spread at Key Levels

Make sure that stock does not have large bid/ask spreads as it approaches your entry points. You will not have much time to place you trade and if you are trading a volatile stock, you most likely will have to execute the orders at market. Large spreads tell me two things; first, your risk increases significantly when the spread increases. Why? Because most times you will have trouble getting out of a stock with a large spread using limit orders and this can turn a small loss into a big one quite quickly. Secondly, it tells me that there is not that much interest in the stock. If there was, the spreads would narrow and both sides would come as close as possible.

Extremely High Volume Stocks

There is trading high volume and then there is trading extremely high volume. I try and stay away from stocks that trade, for example, 30 or 40 million shares as the message of their tapes can be a bit confusing at times if your a beginner. You may see 14 orders come through at bid with large sizes but that may not mean as much as if the stock was trading less volume. Remember to always keep everything in context. If your stock trades gigantic volume, you should expect a different kind of tape action.

Make price prove the point

Up to this point, we have discussed order size, speed, and condition. While these are all key components of the tape, you must let price prove the point. For example, if you are looking to short a stock at $54 and there is strong order flow selling at bid at that level, my experience has shown me to wait for that level to break. If it does not, you may be involved in a trap that was made to get the weak traders out and then take the stock in the opposite direction.

Don’t let your ego get in your way

One of the biggest mistakes that I see many traders making is that they get attached to their positions. In an effort to appease their ego’s, they tend to take a trade and stick with it until they are right. Remember, day trading is an extremely fast game and if you do not react with speed, you will be left in the dust. When you make a decision based on that tape action and the stock does not go in your favor relatively quickly, odds are that you are in a bad trade.

Focus

It is extremely important to have utmost focus when you are trading and trying to listen to the message that tape is giving you. Try and stay in a zone and filter out the extra noise. If you are going to put a trade on, be in that trade and nothing else. This will help you feel when it is right to stay in the stock and when its time to get out.

Conclusion

Tape reading is a very important skill to have as a short term trader and can keep you out of many bad trades. Remember, don’t be an action junkie, psyching yourself up for every trade. If you do this, you will find a reason to put on bad trades in the heat of the moment. Discipline is key and it takes time to develop. For any new traders looking to try this out, please practice, practice, practice before you put your hard earned money at work. Mastering the art of tape reading will take time, but when you do, you will be rewarded.

Tick Charts Definition

Tick charts display a certain number of trades before printing a new bar chart.  Unlike other charts which are based on time, tick charts are solely based on trading activity.  Tick charts are a favorite for day traders who need to make quick trading decisions and do not have the time to wait for a 5-minute bar to close before making the call to sell their stock.   Tick charts can provide a wealth of information about the details of the trading activity, but it can also create a lot of noise.

To try out other time frames such as the 1-minute, 3- minute, 5-minute, 15-minute, etc please use our trading simulator.  We currently offer a free-trial period for 7-days to test drive the application.

Benefits of Tick Chart

Tick charts provide the visual depiction of the time and sales window.  Day traders will look at the time and sales and level-II windows to assess when a stock has run out of steam during a breakout.  The tick chart gives the day trader the ability to see all of this detail within the price chart and removes the headaches that come from staring at the ticker all day.

Most Popular Tick Chart Trading Time Frame

233 ticks is the most popular tick chart trading timeframe.  This is because it is part of the fibonacci series: 0,1,1,2,3,5,8,13,21,34,55,89,144,233.  Whether 233 is the most accurate because of the fibonacci element or if its a self-fulfilling prophecy is irrelevant, all that matters is its the most widely used amongst day traders around the globe.

Importance of Volume with Tick Charts

Tick Charts only display the number of trades that take place.  For example, if there are 233 trades per bar, one would want to know if there are millions of shares traded or just a few thousand.  This information is displayed to the day trader in the form of volume on the chart.  Without the volume, you only have a small piece of the puzzle.

Level II Quotes

The Level II quote window provides the data for pending orders in the market. It displays the size of the best bid and offers with their respective depths. Day traders use level II to gauge the direction of the stock market over the short-term. This article will discuss the working parts of the level II screen based on the tools provided from the tradestation brokerage firm. While level II windows will look differently depending on the broker, the functionality is virtually the same and it provides more information about the trading activity than Level 1.

Level II Window Structure

The level II window structure is comprised of four key components: (1) security information, (2) bid ask window, (3) depth chart, and (4) bid ask orders.

Security Information

The first element of the level II window is the general market information for the security. This information will include the symbol name, direction of the bid tick, last price, and net change. As the bid for the security changes, the arrow will shift up and down and from red to green. The last price is the last recorded price for the security. Finally, the net change represents the total dollar amount change for the security from the previous day’s close.

Stock Ticker

Bid Ask Window The bid ask data contains the current bid ask prices for the security. This data has four columns: (1) price, (2) depth, (3) size, and (4) spread). The price in the bid ask window displays the current bid by the asking price. The depth represents the number of orders at the given price. So, if you have 3 * 1 then there are 3 buy offers for every 1 sell. The size shows you the actual size for the bid and ask orders. So, if you have 1000 * 100, that means there are traders attempting to buy a 1000 shares at the given price, while there is only 100 shares at the sale price. The spread represents the difference between the bid and ask. The tighter the spread, the better. Day traders should look to trade stocks with high volume and close spreads.

Bid Ask Spread

Depth Chart

The depth chart is the visual representation of the orders and their respective size. The color of the graph in the depth chart, will match the color of the bid ask data. If you are day trading attempting to go long, you will want to see the size and speed of the bars on the left side of the depth chart to be larger than the bars on the right. This implies that there are more buyers in the market.

Depth Chart

Bid Ask Orders

The bid ask orders displays all of the pending buy and sell orders in the market. There are four components of the window: (1) ID, (2) order type, (3) size and (4) time. The ID represents the ECN that the order is routed through. The order type will be either the bid or ask depending on which window you are watching. The size is the size of the order. The time represents the time that the order was placed. The bid ask window is the consolidated version of all the bid ask orders. Traders will look at all the bid ask orders in the level II window, to gauge the momentum and to see how many orders are at a particular level.

Bid Ask Window

Example of Level II Window

Level II

One of the most frequent questions I receive revolves around the indicator and chart configuration I use while day trading.  What I am about to discuss is only my preferred setup; you will have to experiment to see what works best for you.  I am hoping that this discussion will guide you down the right path of identifying the best day trading indicators for your trading style.

Chart Time Frame

My charts are set up to use the 5 minute timeframe.  Can you use the 1 minute or even 15 minute setting?  Yes, you can; however, I find that trading 5 minute charts best suit my trading style.  1 minute charts are typically used by scalp traders or those who are only looking for a few cents profit.  While this can be profitable, it is very hard to do so with the costs of commission and slippage that needs to be factored in.  Additionally, I do not want to be trading 100 times per day.  Conversely, 15 minute charts just take too long to develop.  I predominately do most of my trading in the first 2 hours of trading and primarily in the first hour.  A 15 minute chart just does not allow enough information for me to make an informed decision about the dynamics of early morning trading.  In a two hour timeframe, that is only 8 bars versus 24 on a 5 minute chart.

On-Chart Indicators

You could insert hundreds of indicators on your chart but means nothing if you do not understand how to interpret this data.  I take the “less is more” approach to this and keep my day trading indicators to a minimum.  The obvious indicator here is Volume.  This is a must on any chart and is the key to understanding if the bigger players are involved at a breakout area. Secondly, I insert the 10 period and 20 period EMAs to my charts.  Additionally, I keep the ADX, or average directional index, on my charts to gauge the strength behind a trend.  I like to use this indicator to confirm that the trend is strong when day trading breakouts. There are a few other derivative indicators that I have plotted on my charts using Tradestation.  I have a plug-in which automatically plots the pivot points used by floor traders.  The formula for these pivot points are simple to program and can be found in the broad market indicators lesson.  Finally, I absolutely must have the fibonacci retracement levels labeled on my chart before I place a trade.  These levels have an uncanny way of being respected by the trader community and help me identify the risk/reward scenario of a trade. As far as on-chart indicators are concerned, that’s it!

Off Chart Indicators

I use a few off chart indicators.  The first two go hand in hand; the level 2 quote window and the time and sales window, or “tape”, help me gauge the buying and selling pressure at support and resistance areas and basically give more color into the volume indicator that we place on the chart. On a separate screen, I will have all of my broad market indicators, as discussed in our lesson on this.  I will keep a chart of the TICK index up with alerts at the -800, -1000, 800, and 1000 level to inform me of buying of selling climaxes in the market.  I will also keep a chart up on the spread between the S&P futures and the cash market and the TRIN.  Finally, I will have charts up on the S&P identifying Fibonacci levels and pivot points for reference points throughout the day.

Trade Volume Index Definition

The trade volume index (TVI) detects whether a security is being bought or sold based on tick data.  The TVI provides a trader more insight into the amount of buying and selling for a security.  It tracks the total volume that occurs at the bid and ask.  So, if the trade volume index is rising, meaning more people are buying at the ask and the price of the stock is rising, one can assume the uptrend has legs.  Conversely, if the trade volume index is falling and the stock is dropping like a rock, then a stronger downtrend is in play.

Who is using the Trade Volume Index

The trade volume index is used primarily by day trading professionals.  This is because active traders are most concerned with how stocks perform at key levels and have to make swift decisions.  Long-term investors are less concerned with intraday data and focus their attention on how a stock closes at the end of the day.

How to use the Trade Volume Index

The TVI shows its predictive power when assessing a stock that is flat lining at a particular level.  How many times have you been watching a stock at a particular level and wonder whether it has the juice to get through a certain level.  The trade volume index will peel back the onion and show you what traders are doing.  For example, if you want to buy a stock on a break of $100, and it has been flat lining for 2 hours, you may hesitate on pulling the trigger due to the flatness in the market before the breakout.  However, if you see that the TVI has been rising over this 2-hour period, it is a sign that traders are accumulating the stock at the ask price, thus increasing the odds that the stock will have legs when it clears resistance.

How to Calculate the TVI

The trade volume index is calculated by using the following formula

MTV = Minimum Tick Value

Change = Price minus the extreme price since direction changed

If Change is greater than MTV, then Direction = Accumulate

If Change is less than MTV, then Direction = Distribute

If Change is less than or equal to MTV and Change is greater than or equal to MTV, then Direction = Last Direction

Lastly, we must calculate the TVI, which is simple once you know the Direction.

If Direction is Accumulate, then TVI = previous TVI + Volume

If Direction is Distribute, then TVI = previous TVI – Volume

After you finish reading this article on fibonacci trading, try your hand at applying what you have read to real historical tick data using our trading simulator.  You can test drive the #1 trading application in the world; consider this our way of saying we believe in our product.

Fibonacci ratios, when applied to trading stocks, correlate two trends; let’s refer to them as primary and secondary.  The primary trend refers to a trending move in one direction while the secondary trend will refer to counter trend moves in the opposite direction.  The three most common fibonacci retracement levels are 38.2%, 50%, and 61.8% of the primary trend and most basic stock charting applications will use these as standard levels.  These fibonacci retracement levels act almost as magnets once the counter trend rally takes place.  These are very common, however, there are a few other fibonacci levels that can provide resistance.  These are the 75%, 78.6%, 87.5%, and 88.7% retracement levels.  The common rule of thumb is that when the 50% retracement level is taken out, the four levels I just mentioned become magnets to attract price.  Price action must be analyzed at those levels to understand if the counter trend move will cease or whether it will continue to fully retrace the primary move. Fibonacci retracement levels are used by many floor traders and therefore become very relevant to your fibonacci trading activities.  These levels are so widely used now by traders, including systematic trading, that they almost become a self-fulfilling prophecy.   Some advanced traders will take it a step further and add fibonacci arcs and fibonacci fans to their trading arsenal, in search of an edge.

Defining the Primary Trend

Let’s start with the characteristics of the primary trend of which we would want to play the countertrend.  I found that fibonacci retracement levels are most accurate after the primary trend has been a sharp move in price accompanied by heavy volume at the end of that move.  These types of moves typically exist in the story stocks of the day or the appear on the list of highest percentage gainers or losers list which complements my trading style as these are the only stocks that I will trade. I am asked many times how to define the starting and ending points in order to calculate the length of the primary trend.  I see many traders make the mistake of using the highest point and lowest point of a trending move to define the starting and ending point of the primary trend.  While this may work in some cases, it is best to look for double tops or double bottoms when locating your starting and ending points.  This may or may not coincide with the highs or lows of the move.

How to Use Fibonacci Levels

I do not use fibonacci levels as a primary trading technique, however, I found that it greatly improves my odds of generating a winning trade when fibonacci retracement levels start correlating with price objectives using other patterns, such as candlestick charting formations for example.  I use fibonacci levels in two ways: 1)  After identifying the primary trend, use price reversal pattern recognition (through candlesticks or any other trading technique that you employ) to coincide with a fibonacci retracement level to confirm that the countertrend move has ceased.  I then look for the stock to test the recent lows and double bottom or break through that level.  That is where I employ the usage of tape reading to determine whether I should play the double top/bottom or whether I should play a breakout in the direction of the primary trend. 2)  Many times, a stock will spike down on high volume and that will signal capitulation and put a floor in the market.  Usually, an automatic rally will ensue and fail when the dip buyers lose their buying pressure.  Oddly enough, this coincides with fibonacci retracement levels (usually 38.2% or 50%).  Once that rally kicks in, a retest of the recent lows will be attempted and a trading range can be created between the lows that were put in with spike volume and the highs of the automatic rally.  This trading range carries on for a bit of time before a breakout up through the range occurs.  This breakout can be bought with good tape action and then the tape action must be hawked as well as keeping an eye on fibonacci levels which could act as resistance.  If I see buying pressure fizzling out at one of the key fibonacci levels mentioned above, I get out of the trade immediately. As you can see, fibonacci trading is a secondary part of my game but a pivotal one.  You can really hit the sweet spot in trading if you can combine a few key trading elements together and design your own trading system where you put the odds in your favor.  The bottom line, you probably shouldn’t leave fibonacci retracement levels out of that mix.

Day Trading Indicators

Day trading on any timeframe chart requires the knowledge of how the general market is behaving.  You want to make sure that all boats are sailing in the same direction to give your trade better odds of working.  To do this, a trader should keep an eye on a few key day trading indicators; the TICK Index, TRIN index (or the ARMS Index), the Spread between the S&P Futures & Cash markets, and major support and resistance levels (including Fibonacci levels and pivot points).  Day traders have about 1 hour to profit during the “power hour”, starting at the open.  For this reason, you want to look at leading indicators rather than ones which are lagging.  We have to make quick decisions as to the future health of the market and these indicators will help us do that.

TICK Index

The TICK Index is a measurement of the short term bias of the overall market at any one point in time and is one of the most important day trading indicators.  It measures the difference between the number of stocks on the NYSE that have registered an uptick versus the number of stocks that have registered a downtick at any single point in time.  While a trader cannot bother themselves with the noise of every tick index reading, it is important to keep an eye on extremes in the market, especially 1000 and -1000 which indicate an overbought or oversold condition.

Trin (ARMS Index)

The ARMS index, aka. TRIN index, measures the breadth of the market in terms of volume and advancing issues.  Essentially, it gauges whether the market is moving higher with volume support.  Just like the TICK Index, there can be a lot of noise; however, keep an eye out for closing TRIN readings near 2 and .5.  These can signal a change in trend on the following days open.  On intraday charts, you want to see the TRIN and the price moving in opposite directions.  When that stops happening, it is time to look for a change in trend.

Premium on the S&P Futures

Next, we will discuss the spread between the S&P cash and the S&P futures contract.  This spread is often referred to as the premium or discount.  It is said that the futures market leads the cash market and that an expansion in this spread indicates that the cash market should move higher while a contraction indicates that the market should move lower.

Support and Resistance Levels

Bigger support and resistance levels of the overall market should also be understood when you are day trading.  Remember, we want all boats to sail in the same direction.  Therefore, it is important to identify the next trading days pivot points and Fibonacci retracement level.  These will provide some clues as to strong support or resistance within the market.

Pivot points are very rarely talked about but used by the majority of traders in the futures trading pits.  The most common method of calculating pivot points is known as the five point method and these need to be recalculated every day to provide intra-day support and resistance levels.

The calculations of these pivots use the previous days data and are as follows:

Resistance 1 = (Main Pivot * 2) – Low
Resistance 2 = Main Pivot + Resistance 1 – Support 2
Main Pivot =  (Close + High + Low) / 3
Support 1 = (Main Pivot * 2) – High
Support 2 = Main Pivot – Resistance 1 + Support 2

While they are not considered day trading indicators by the definition, you must keep an eye on these important levels to avoid giving back gains due to reactions at these levels.

What is the Tick Index?

The tick index measures the very short term health of the markets by taking the difference between the number of stocks on an uptick and the number of stocks on a downtick.  The Tick index sums up this difference for all stocks in the New York Stock Exchange.  For example, if there are 3000 stocks on the NYSE and 2000 of them printed an uptick while 700 printed a downtick, the tick index would read as +1300.

How to Use the Tick Index When Day Trading

If you take a look at this chart, it will look like a bunch of noise.  That is mostly correct; we want to use this chart to recognize extreme buying and selling activity.  That extreme buying and selling displayed by the Tick warrants caution or even a reversal in the opposite direction.  We want to pay attention to tick readings of +/-600, +/-800, and +/-1000.  We keep an eye on the 600 level as it will signal a possible move to 800 or even 1000. When we are in a losing day trading long position and the tick reaches 800, think about selling out.  The market may be climaxing to the upside and the fact that you are in a losing position indicates that the position is not a good one. I use readings of 1000 and -1000 to scale out of all long and short positions and even think about going the opposite way of the market. Notice how 1000 and -1000 produced decent intra-day reversals in the S&P 500.  The higher the tick readings, the more powerful the reversal signals may be.

Tick Index

Advance Decline Ratio Definition

The advance/decline ratio (A/D ratio) shows the ratio of advancing issues to declining issues. The A/D ratio is similar to the advance/decline line, except instead of subtracting the advancing and declining issues, it divides these two inputs. The benefit of using the advance/decline ratio is that it is a constant number, versus the advance decline line, which will constantly trend higher as new stocks are added to the New York Stock Exchange. Below is the formula for calculating the advance decline ratio.

Advance Decline Ratio Formula

Advancing Declining Issues

Interpreting Advance Decline Ratio

Interpreting the advance/decline ratio can prove to be a difficult task. The ratio will move erratically and on quick glance it is a bit challenging to make clear observations about the health of the market. A popular technique is to place a moving average of the A/D ratio to assess the direction of the technical indicator. The average of the indicator will begin to oscillate back and forth and will provide clues as to whether the market is oversold or overbought. The A/D ratio will never have a negative value. Traders can use the following values for estimating the trend of the market:

• A/D ratio > 1.25 bullish
• A/D ratio is between 0 and 1, bearish to choppy market
• A/D ratio > 2 extremely bullish

Advance Decline Ratio Charting Example

Advance Decline Ratio

Why is Volume Important?

Volume

Volume analysis is the technique of assessing the health of a trend, based on volume activity. Volume is one of the oldest day trading indicators in the market.  I would dare to say the volume indicator is the most popular indicator used by market technicians as well.  Trading platforms may not have a particular indicator; however, I have yet to find a platform that does not have volume.

In addition to technicians, market fundamentalist also take notice to the number of shares traded for a given security.

Bottom line, the volume indicator is one of the simplest methods for observing the buying and selling activity of a stock at key levels.  The tricky part is volume can provide conflicting messages for the same setup.  Your ability to assess what the volume is telling you in conjunction with price action can be a deciding factor for your ability to turn a profit in the market.

In this article, we will cover how to assess the volume indicator to help us determine the market’s intentions across four common setups:

1. Breakouts
2. Trending Stocks
3. Volume Spikes
4. False Breakouts

Strategy 1 – Breakouts and Volume

Traders will often look for breaks of support and resistance to enter positions.  For those fans of the Tradingsim blog, you know that I exclusively trade breakouts in the morning of each session. There are two key components to confirm a breakout: (1) price and (2) volume. When stocks break critical levels without volume, you should consider the breakout suspect and prime for a reversal off the highs/lows.

The below chart is of Netflix on a 5-minute time interval.  You will notice that Netflix was up ~15% throughout the day after a significant gap up.  Can you tell me what happened to Netflix after the breakout of the early 2015 swing high?

Breakout of Swing High

The interesting thing about the Netflix chart is that the stock never made a new high after the first 5-minute bar.

NFLX – Flat for the day

This is a prime example where a stock may have broken a high from a few weeks ago, but is unable to break the high for the current day.  As day traders, you want to wait until the high of the day is broken with volume.

A key point for you is that every swing high does not need to exceed the previous swing high with more volume.  I used to obsess over this and if I didn’t see more volume I would walk away from the trade.  Looking at the chart of Netflix above, do you honestly think the stock will exceed the first 5-minute bar with increased volume?  Of course not!

While this charting example did not include a break of the daily high, when you look for stocks that are breaking highs, just look for heavy volume.  Please don’t beat yourself up because the 9:35 bar had 150,000 shares traded and the break of the high at 10:10 am only had 132,000.

Now if you see a break of a high with 50% or 70% less volume, this is another story.  Again, if we are within the margins, please do not beat yourself up over a few thousand shares.

In a perfect world, the volume would expand on the breakout and allow you to eat most of the gains on the impulsive move higher.  Below is an example of this scenario.

Valid Breakout

Let’s test to see if you are picking up the concepts of breakouts with volume.  Take a look at the below chart without scrolling too far and tell me if the stock will continue in the direction of the trend or reverse?

Breakdown or not?

Come on, don’t cheat!

Breakdown

The answer to my question – you have no idea if the stock will have a valid breakout.  From the chart, you could see that the stock had nice down volume and only one green candle before the breakdown took place.  This is where experience and money management come into play, because you have to take a chance on the trade.

You would have known you were in a winner once you saw the volume pickup on the breakdown as illustrated in the chart and the price action began to break down with ease.

For those that follow the blog, you know that I like to enter the position on a new daily high with increased volume.  You will need to place your stops slightly below the high to ensure you are not caught in a trap.  This strategy works for both long and short positions.  The key again, is looking for the expansion in volume prior to entering the trade.

In Summary

1. The stock has volatile price action with the majority of the candle color mirroring the direction of the primary trend (i.e. red candles for a breakdown and green candles for a breakout).
2. On the breakout volume should pickup
3. The price action after the breakout should move swiftly in your favor

Strategy 2 – Trending Stocks and Volume

When a stock is moving higher in a stair-step approach, you will want to see volume increase on each successive high and decrease on each pullback. The underlying message is that there is more positive volume as the stock is moving higher, thus confirming the health of the trend.

This sort of confirmation in the volume activity is usually a result of a stock in an impulsive phase of a trend.

Volume Increase

The volume increase in the direction of the primary trend is something you will generally see as stocks progress throughout the day.  You will see the strong move into the 10 am time frame, a consolidation period and then acceleration from noon until the close.

For this strategy, you will want to wait for the trade to develop in the morning and look to take a position after 11 am.  For those that follow the blog, you know that I do not trade in the afternoon; however, this doesn’t mean you can’t figure it out.

As the stock moves in your favor, you should continuously monitor the volume activity to see if the move is in jeopardy of reversing.  The speed of this setup is much slower versus the other strategies discussed in this article; however, the difficulty reveals itself in the increased number of false moves, which are commonplace in the afternoon.

Think I’m kidding about false breakouts, let me show you a couple.

Weak Trend 1

Weak Trend 2

These charts are just a sample of what happens far too often when it comes to afternoon trading.  So, how do you find the stocks that will trend all day?  After many years of trading, I can tell you I honestly don’t know.

In Summary

1. Look for volume to push the stock in the direction of the primary trend
2. You need to be prepared to hold a stock for multiple hours in order to reap the real rewards
3. Once you figure out how to identify the stocks that will trend all day prior to 10 am, please shoot me an email
4. Instead of using volume to predict which stocks will trend, simply use volume as an indicator that keeps you in a winning position

Strategy 3 – Volume Spikes

Volume spikes are often the result of news driven events. It occurs when there is an increase of 500% or more in volume over the recent volume average. This volume spike will often lead to sharp reversals, since the moves are unsustainable due to the imbalance of supply and demand. Trading counter to volume spikes can be very profitable, but it requires enormous skill and mastery of volume analysis.

These volume spikes can also be an opportunity for you as a trader to take a counter move position.  You really need to know what you are doing if you are going to trade volume spikes.  The action is swift and you have to keep your stops tight, but if you time it right, you can capture some nice gains.

Let’s walk through a few volume spike examples, which resulted in a reversal off the spike high or low.

In the below example we will cover the stock Zulily.  The stock had a significant gap up from $13.20 to almost $16.

Volume Spike Reversal

Notice how the stock never made a new high even though the volume and price action was present.  This is a key sign that the bears are in control.  For this setup, you will want to focus on the following key items:

In Summary

1. The high or low of the first candle is not breached
2. The first candle has significant volume
3. The subsequent heavy volume events further establish the reversal in trend from the initial spike at the open
4. Place your stops directly above the high or low of the first candle

Volume Spikes with Long Wicks

The other setup with volume spikes are candlesticks with extremely long wicks.  In this scenario, stocks will often times retest the low or high of the spike.  As a trader, you can take a position in the direction of the primary trend, after the stock has had a nice retreat from the initial volume and price spike.

Below is an example from a 5-minute chart of the stock Depomed, ticker DEPO.  You will notice how the stock had a significant gap down and then recovered nicely.  Once the recovery began to flat line and the volume dried up, you will want to establish a short position.

Long Wick

Let’s take another look at a long wick setup.  The below chart is of Frontier Communications, ticker FTR with a long wick down.  The stock then recovered and went flat, which was an excellent time to enter a short position.

Another Long Wick

In Summary

1. Identify a high volume gap with a long candlestick on the first bar
2. Wait for the stock to eat into the morning gap and volume to drop off
3. Take a position in the direction of the primary trend with a price target of the low or high of the wick

Strategy 4 – Trading the Failed Breakout

I would be remiss if I didn’t touch on the topic of failed breakouts.  As a day trader that specializes in early morning breakouts, I have my fair share of trades that just don’t work out.  So, how do you know when a trade is failing?  Simple answer – you can see the warning signs in the volume.

Let’s dig into the charts a bit.

False Breakout 1

Above is the chart of Amazon and you can see the stock attempted to breakout in the first hour of trading.  Notice how the volume on the breakout attempt was less than stellar.  As a trader, you shouldn’t be surprised when the stock begins to float sideways with no real purpose.  While this would have been a bad trade, because your money is idle, it’s still much better than what I’m getting ready to show you next.

False Breakout 2

The above example of ESPR would drive me crazy 6 years ago.  Notice how the volume dries up as the stock attempts to make a lower low on the day.  The key for you as a trader to get out is the price action begins to chop sideways for a number of candles.  When you sit in a stock hoping things will go your way, you could just make a donation to charity.  At least the money will go to a worthy cause.

In Summary

1. Breakouts fail quite often
2. If the volume dries up on the breakout, look to get out within a few candles if things don’t turnaround
3. If you want to play the reversal, wait a few candles to see if the peak holds and enter a trade counter to the morning gap
4. You can use the peak of the first candlestick as a logical point to exit the trade

In Conclusion

The strategies discussed in this article can be used with any stock and on any time frame.  The most important point to remember is you want to see volume expand in the direction of your trade.  Keep this in the back of your mind and you will do just fine.

Let’s Improve Your Trading Performance

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To see how Tradingsim can help improve your bottom-line numbers, please visit our homepage.

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Story Highlights

• The average true range (ATR) is a great tool for determining the level of volatility across stocks to align your investment choices with your risk profile.
• The ATR should not be used to identify stop loss and exit targets as past volatility is not a predictor for future activity.  This average true range trading strategy has a number of flaws, which are identified in this article.

What is the average true range indicator?

The average true range indicator is an oscillator, meaning the ATR will oscillate between peaks and valleys.  The ATR has no upper or lower limit bounds like the RSI or slow stochastics.  The other unique characteristic of the ATR is the value of the indicator is based on the price performance of the stock in question.  Therefore, Apple may have an ATR of 15, while Baidu may have an ATR of 38.  This lack of consistency makes the ATR a favorite in my trading toolkit, because it requires the technical analyst to assess the stock’s volatility on a case-by-case basis and not make general assumptions about a stock’s performance.

Average true range formula

Let us quickly cover the average true range formula, so we can focus on how to use the ATR.

The ATR formula is comprised of three key inputs, which is why the word “true” is in the title, because these three inputs provide a more holistic view of a stock’s trading activity.

How to Calculate the Average True Range

The average true range is comprised of three inputs, which are helping identify the volatility of a security.  To determine the level of volatility there are three ranges included in the equation

Input 1 – Current Day’s Range

Current High – Current Low

$75 – $70= $5

Input 2 – How High has the security risen from the previous day’s close

Absolute Value (Current High – Previous Close)

($75 – $80) = 5

Input 3 – How low has the security dropped from the previous day’s close

Absolute Value (Current Low – Previous Close)

($70 – $80) = 10

The highest value of the three inputs is the ATR, so in the above example 10 is the ATR for this point in time.

In order to calculate the average true range, you take the average of each true range value over a fixed period of time.  For example, when calculating the average true range for a 14-day period you would take the average of the true ranges over 14-days.

For more information on average true range calculators, excel formulas and history, below are a list of great sources:

Average True Range Excel Example – Invest Excel (You will need to scroll down near the bottom of the article to locate the download spreadsheet link)

To uncover the history and origins of the Average True Range you will want to read the book by the ATR creator, J.Welles Wilder – titled ‘New Concepts in Technical Analysis’.

Average True Range Chart

Average True Range of Apple on a 5-minute chart

The average true range is an off-chart indicator, meaning you will plot the indicator above or below the price chart.  For me, I prefer to have the average true range below both the price chart and volume indicator.

As you can see from the above chart example of Apple, the average true range moves lockstep with the price action as the stock moves from highs to lows.  The one key differential for the average true range is that the indicator will experience extreme highs and lows based on the volatility independent of price direction.  Remember, the ATR is based on the absolute value, so you can have a high ATR value as a stock is plummeting.

How to Use the Average True Range Indicator

The average true range indicator is a volatility measure of a stock’s performance. Below are the key ways traders use the indicator:

1. Gauging a stock’s volatility
2. Stop Loss/Exiting a Trade

Gauging a stock’s volatility

One of the greatest challenges for new traders is avoiding drawdowns on their account.  Drawdowns are what kills a trader’s ability to consistently earn over the long haul and creates enormous emotional pain and turmoil.

Drawdowns are a result of two factors: (1) over leverage and (2) extremely volatile stocks.  One could argue that if you get number 1 right, the volatility is irrelevant; however, these two elements are not always mutually exclusive.

Early on in my trading career I would have the standard rule of I only want to use “x” amount of dollars or risk “x” amount of dollars per trade.  The challenge I would face after entering the position is that the stock would move wildly in one direction or another in ways that I either did not anticipate or were not accustomed.

I quickly realized that I needed a common method for not only identifying great setups, but also a way to rate a stock’s volatility.

To this aim, I began researching the average true range indicator.

The problem I had with the ATR is that the indicator’s value was different for each stock.  Higher priced stocks had higher ATRs versus the low priced momentum players.

In order to find a universal method for assessing the risk, I divided the ATR by the stock price to establish a ratio of the range relative to the stock’s price.  Using the above chart example, take the 14-period ATR divided by the closing price of Apple on the 5-minute chart (.42/$126.39) = .0033.

On the surface, this .0033 means absolutely nothing.  Now, let us apply the same math to a more volatile stock.

ATR XOMA Chart

XOMA has a stock price of $3.15 with an ATR of .04 which gives us a volatility ratio of (.04/$3.15) = .0126.  .0126 is 3.84 times greater than .0033, which is the volatility ratio for Apple on the same 5-minute time frame.  Therefore, a trader would need to give XOMA more wiggle room as the stock is likely to have greater percentage moves up and down.

Now that we’ve mastered basic arithmetic, let’s walk through how to apply this to your trading regimen.

As you begin to analyze the volatility ratio of stocks, you will begin to identify the stocks that have just the right mix of volatility for your trading appetite.  Meaning, over time you will identify the right mix of volatility that gives you the returns you want with just the right amount risk.

For you, your volatility range could be .012 – .02.  Alternatively,  you could be more conservative and want to only trade stocks with a volatility ratio of .0025 – .0050 on a 5-minute range.

The key thing to remember when determining which volatility ratio works best for your trading style is to stick to one time frame.  You cannot evaluate the 5-minute volatility ratio and then compare that to a daily volatility ratio, even if it is the same stock.  The common thread is the timeframe; otherwise, you are comparing apples to oranges.

Stop Loss/Exiting a Trade

The key to making money in the market is buying a stock for less than what you want to sell the stock.  This is a basic concept, but easier said than done.

When attempting to identify a great entry point, a key indicator that a stock is likely in the process of going counter to the primary trend is a drop off in volatility. In theory, this equates to diminishing price movement, which implies that either the buying or the selling interest is tapering.

So, how do we use the average true indicator as an early sign that the stock is likely going to have a change in trend, so we know where to execute a stop loss to exit a trade?

For newbie traders, this explanation will get a bit muddy, but do the best you can to stay with me.

The below chart is of Apple from the time period of late April through early May.  Apple had a nice run up from $125 through $134, only to retreat down through $125.

Looking at the ATR, do you have an idea of where to place the average true range stop loss?

ATR Apple Example

In simple terms, you will apply a multiplier to the ATR value to determine your profit and stop loss values.  The key of course is making sure your multiplier for the target price is greater than the stop loss, so over a series of trades you have a greater likelihood of turning a profit.

In the Apple example above you would take the ATR value of .29 and then apply for example a 3x multiplier for your target and 1x for your average true range stop.  This would provide you a target price of (.29 *3) + $126.47 = $127.34.  Conversely, the average true range stop loss for this trade would be $125.6.

On paper, this makes a lot of sense.  For every dollar you risk, you can make up to 3 times in profits.  Following this model, you could have more losing trades than winners and still be in the black.

However, as I evaluate the use of applying this average true range exit strategy, I see a number of flaws.

For starters, applying a multiplier to the average true range during a dull trading period will limit you in the potential gains as your profit targets are relative to the most recent trading volatility.

In terms of stop loss, if a stock is in a whipsaw-trading period, then you will likely be stopped out due to the tight price action.

If you could only use the ATR to determine when to get in and out of trades wouldn’t life be grand?  In reality, you will need additional confirmation for what the ATR is telling you and what better confirmation than price?

How to Use the Average True Range for short-term trading

Using the ATR to assess the price movement is a much better usage of the ATR.  Having the ATR act as a profit target and stop loss mechanism is asking too much of the indicator.

Let’s take another look at the 5-minute Apple chart when we combine both the ATR and price channels.

Price and Average True Range Spike

The same way stock prices will trade in clear trends, so can indicators such as the ATR.  Notice in the intraday chart of Apple, both the ATR and stock price were in channels of sorts.  The ATR was in a clear horizontal channel with low volatility, while Apple’s stock price stayed in a clearly defined uptrend.

This combination of low volatility combined with a clear up trend let’s you the trader know that the up move is measured and can be traded with high confidence.

Then just as the market lulls you to sleep, volatility will rear its ugly head to ruin the parade.

Again, I am not a user or believer of ATR as a standalone indicator for determining stop loss or profit targets when trading.  However, one cannot deny the power of combining the ATR with price action to identify a likely change in trend.

Notice how the ATR and price both spike at the same time in the Apple chart.  More importantly, notice how the price spikes right through the support line.

In every other touch point of the support line within the channel, the ATR remained in its tight horizontal trading range. As a trader, the violent break and ATR spike should have set off all types of alarms that the easy money was no longer available.

Apple managed to muster up one last push higher, before the stock had a swift sell off taking the stock back to the starting point of the preceding rally.

Someone could make the argument that of course Apple reversed; you could see how quickly the price moved down…no brainer.  Well, yes and no.  By having the pulse of Apple’s volatility over the preceding weeks, you could see the magnitude of the move in terms of volatility that is otherwise unclear by only reviewing the price chart.

In Summary

The ATR is a powerful tool, which I use in both my day trading and swing trading activities.  As you further explore the indicator, remember that the real power of the ATR is in its ability to judge the “frenzy” and the “calm” in a security.

To quickly recap, below are the key takeaways from this article:

1. Use the ATR to Gauge the risk of a trade prior to entering the position.  If you like the slowness of IBM, you should not trade a $3 dollar biotech.
2. Do not use the ATR for placing stops and profit targets.  Again, if you use the ATR to create a profit target right before a massive breakout, you will likely gain a fraction of the true profit potential.

To further explore the ATR, please test-drive your theories using the #1 Market Replay Tool – Tradingsim.com.  In addition to the ATR, we have a host of other technical indicators and studies, which you can practice using in a stress free environment with real historical tick data to see what works best for your trading style.

Good Luck Trading,

Al

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Fans of the Tradingsim blog know that I am big on volume.  Volume is probably one of the oldest off chart technical indicators you will find in technical analysis.  So, as I’m looking through the technical indicators I have been intrigued by the possible uses of the volume oscillator indicator.

The volume oscillator displays the relative strength of a shorter volume moving average to a longer one.  To keep things super simple, whenever there is a positive reading for the volume oscillator, there is strength on the short-term in the direction of the primary trend.  If the volume oscillator is in the negative territory, volume is lacking and a change in trend is likely.

In this article, I will cover 4 strategies for how to trade with the volume oscillator.  If you are looking for how to calculate the volume oscillator and more of a technical definition of the indicator, please visit the TA-Guru.

From a guy that believes that volume is the key to identifying the strength of a trend and where the smart money is placing their bets, the volume oscillator provides an interesting perspective for how to view market activity.

We all have seen the volume bars at the bottom of the chart which shows trading activity like the chart below:

Volume Example

As a trader, you will look for when volume is drying up and when volume is accelerating.  The red and green volume bars provide us an indication of how the price closed.  Nevertheless, what is the volume actually telling you about the future direction of the trend?

Depending on the trade setup and volume at previous peaks or troughs, the market could be sending you a number of signals.

Interpreting these signals is where the volume oscillator can provide clarity on where the stock could be headed.

In the following examples, I will be using 5 periods for the short-term and 10 periods for the long-term, as these are the defaults in the Tradingsim platform.

#1  – Breakout Confirmation

Breakouts have a high failure rate in the market, because these are levels, which are very visible to all traders.  There isn’t some mystical Fibonacci level or complicated trendline; it comes down to a break of a recent high or low.  Let’s take a look at a few breakout examples and the corresponding readings of the volume oscillator.

Apple Breakout

The first example is of a breakdown of Apple on a 5-minute chart.  Notice how as Apple approaches the previous swing low, the volume oscillator spikes higher.

Volume Oscillator Spike

The previous swing low had a volume oscillator spike in the neighborhood of 23.42, while this break had a reading of 31.74. So, does this guarantee the price will continue lower?  Absolutely, not!

The way you should interpret this is that the amount of selling pressure increased on the retest of the swing low.  At this point, one of two things can happen:  (1) Apple would reverse sharply as a selling spike could lead to a trend reversal or (2) Apple will continue lower as the bears are in control.

Let’s fast forward in time to see how the action played out for Apple.

Apple Much Lower

Now that we have shown the happy path, let’s dig into an example where the volume oscillator failed.

Volume Oscillator False Signal

On this breakout, Apple had a nice spike in the volume oscillator on the positive side, which should have resulted in a continuation of the breakout.  However, as you look at the chart, you will notice that Apple actually reversed at this critical level and generated a bull trap.

How could you have known that the signal was false?

On the surface, there really wasn’t anyway for you to have known that Apple was destined to reverse and head lower by simply looking at the volume oscillator in a vacuum.

Just as with any other indicator, you need to see both price and volume confirm the move.  Once the price action began to creep back below the breakout level, that was your cue to exit the position.

If you get nothing else out of this section of the article, remember that you cannot trade breakouts with the volume oscillator blindly.  You must have some predefined method for confirming the trend.

#2 – Riding the Trend

Volume in a strong uptrend or downtrend can be quite deceiving.  The volume will appear to just float with little fan fair as the stock continues in the direction of the primary trend.  This can prove challenging to interpret, because it’s as if the market is floating with little purpose when in actuality the lack of push from participants should trigger a reversal.

Let’s look a look at the perfect example where the volume oscillator would have kept you in a position.

volume oscillator and strong trend

First, let me say that I personally hate these types of charts, because it leads people to believe you can find these setups on a daily basis.  Let me be clear, they are super rare.  You are better served making consistent profits instead of looking for these 90-degree charts.

Now that I have placed the disclaimer, PBMD had a massive intraday move.

After clearing resistance at the $3 dollar level, the stock began to rally significantly all the way up to $6 dollars.  Looking back at the chart, there was no reason present to sell, but let me tell you that sitting with that much of a paper profit on a day trade is one of the toughest things you can face in life.

Upon further review, you can see that the volume oscillator did a nice job of containing the trend as the oscillator never dipped below the zero line.  This tells you as a trader that the short-term strength in volume was behind the move and the stock was headed to higher ground.

The likelihood of you finding a stock that hovers above its 0 line on the volume oscillator will be hard to find, but when all starts align, it’s a beautiful thing.

#3 – Volume Oscillator and Choppy Markets

You figure this one out and I will give you a gold medal.  The volume oscillator in my humble opinion provides a ton of false signals when the market is trading in tight ranges.  The price and volume action will look non-existent, yet the oscillator could be moving above and below the 0 line.  As a trader, this would really annoy me as the appearance of underlying strength or weakness is nothing more than a false signal.

Let’s look at a few chart examples for clarity.

Volume Oscillator and Choppy Markets

Is it me or do the spikes in the oscillator make it appear as though there is more going on in this chart?  The bottom-line is that we have no idea which way the stock will break and only time will tell whether the bears or bulls are correct.

What you can see using the volume indicator is that there is an increase in the volume when the stock finally broke support.  Which is a perfect segue into the next section of this article.

#4 – Drawing Trendlines on the Volume Oscillator

Another method used to trade with the Volume Oscillator is to actually draw trendlines on the indicator.  The goal here is to identify breakout patterns on the indicator to signal the stock price will also likely start trending.  I’m not a big fan of this approach as it starts to clutter your chart and I feel like the breakout is just a coincidence as you are working with a large number of data points.  At times the volume oscillator will breakout prior to the trend and other times it won’t.

It’s just the law of averages.

Below is an example of where the volume oscillator was able to break through a trendline, as price was also making a breakout on the chart.

volume oscillator trendline breakout

In the above example, Hawaiian Holdings (HN) had a breakout of the volume oscillator and then a back test of the trendline prior to breaking out.  I haven’t run a detailed analysis on how often this occurs, but again my gut tells me that it boils down to at some point, lines on a chart start to tell the same story.  It just so happens these stories are just by chance.

Volume Oscillator versus Volume

Here is the real test.  Does the volume oscillator add any additional value that isn’t already present in the volume indicator?

The reason I am asking this question is because traders as a whole need to simplify their methodology.

Trading is the same way.  As you begin to hone your craft, you may find yourself in a trap where you are adding more and more indicators on the chart.  Call it a security blanket, insecurity or just over thinking it, your chart can begin to fill up.

So, always challenge your desire for one more indicator.

volume oscillator versus volume

In this example, we are looking at ACHC on a 5-minute timeframe.  Notice how the stock shot up on high volume.  After the initial breakout, ACHC consolidated for a few candles and then screamed higher again.  As you can see in the volume activity, this was a huge surge as the volume was many multiples higher than the average.

Now take a look at the volume oscillator.  The oscillator definitely made a strong move higher, but the oscillator failed to drastically exceed any of the recent peaks for ACHC.

Therefore, the answer to this question is because the short-term and long-term periods are 5 and 10 respectively.

If we expand the delta between the slow and fast periods, the volume spike is a bit clearer, but not by much.

While the peaks are a bit clearer, the volume oscillator doesn’t come close to standing out as well as the volume indicator.  Why do you think this is the case?

Simply put, as the slow and fast volume averages surge higher, they do so relative to each other.  Therefore, you will never get the contrast you would find looking at each volume bar side-by-side.

Final Verdict

The volume oscillator like any other indicator can prove useful when combined with price action and trend lines.  I do however, feel like in the long run, it’s better to have a solid understanding of the volume indicator to ensure you can see the bigger picture and not get too lost in the spikes of the volume oscillator.

If you still want more regarding the volume oscillator, please check out this informative video posted by Jeff Bierman on YouTube.

I hope you found this article helpful and if you want to test drive the volume oscillator for yourself, feel free to visit our homepage to gain a better understanding of the Tradingsim Platform.

Much Success,

Al

The post 4 Strategies for How to Use the Volume Oscillator appeared first on - Tradingsim.

Awesome Oscillator

I don’t know about you, but what was Bill Williams thinking when he came up with the name awesome oscillator?

With names floating around as complex and diverse as moving average convergence divergence and slow stochastics, I guess Bill was attempting to separate himself from the fray.  To learn more about the awesome oscillator from its creator, check out Bill’s book titled ‘New Trading Dimenstions:  How to Profit from Chaos in Stocks, Bonds, and Commodities’.

In this article, we are going to attempt to better understand why Bill felt his indicator should be considered awesome by evaluating the three most common AO trading strategies and a bonus strategy, which you will only find here at Tradingsim.

So what is the Awesome Oscillator?

Well by definition, the awesome oscillator is just that, an oscillator.  Unlike the slow stochastics, which is range bound from +100 to -100, the awesome oscillator is boundless.

While on the surface one could think the awesome oscillator is comprised of a complicated algorithm developed by a whiz kid from M.I.T., you may be surprised to learn the indicator is a basic calculation of two simple moving averages.  That’s right folks, not an EMA or displaced moving average, but yes, a simple moving average.

Awesome Oscillator Formula

To my earlier point, if you have a basic understanding of math, you can sort out the awesome oscillator equation.  The formula compares two moving averages, one short-term and one long-term.  Comparing two different time periods is pretty common for a number of technical indicators, the one twist the awesome oscillator adds to the mix, is that the moving averages are calculated using the mid-point of the candlestick instead of the close.

The value of using the mid-point allows the trader to glean into the activity of the day.  If there was a ton of volatility, the mid-point will be larger.  If you were to use the closing price and there was a major reversal, you would have no way of capturing the volatility that occurred during the day.

The fact Bill saw the need to go with the mid-point, well is a bit awesome.

Fast Period = (Simple Moving Average (Highest Price + Lowest Price)/2, x periods)

Slow Period = (Simple Moving Average (Highest Price + Lowest Price)/2, x periods)

Awesome Oscillator = Fast Period – Slow Period

One point to clarify, while I listed x in the equation, the common values used are 5 periods for the fast and 34 periods for the slow.  You however, reserve the right to use whatever periods work for you, hence the x in the above explanation.

Awesome Oscillator on the Chart

Depending on your charting platform, the awesome oscillator can appear in many different formats.  Nevertheless, the most common format of the awesome oscillator is a histogram.

The awesome oscillator will fluctuate between positive and negative territory.  A positive reading means the fast period is greater than the slow and conversely, a negative is when the fast is less than the slow.

The one item to point out is that the color of the bars printed represent how the awesome oscillator printed for a period.  Hence, you can have a green histogram, while the awesome oscillator is below the 0 line.

Awesome Oscillator Histogram

Basic Awesome Oscillator Trading Strategies

Now that we are all grounded on the awesome oscillator, let’s briefly cover the 3 most common awesome-oscillator day trading strategies.

#1 – Cross Above or Below the Zero Line

If you use this strategy by itself, you will lose money.  I hate to speak in such absolutes, but to trust an indicator blindly without any other confirming analysis is the quickest way to burn through your cash.

Wow, did I just go off like that without further explanation?

I’m back.  Therefore, the strategy, if you want to call it that, calls for a long position when the awesome oscillator goes from negative to positive territory.  Conversely, when the awesome oscillator indicator goes from positive to negative territory, a trader should enter a short position.

Without doing a ton of research, you can only imagine the number of false readings you would receive during a choppy market.

Let’s look at a chart example to see the cross of the 0 line in action.

Awesome Oscillator 0 Cross

In the above example, there were 7 signals where the awesome oscillator crossed the 0 line.  Out of the 7 signals, 2 were able to capture sizable moves.

This 5-minute chart of Twitter illustrates the main issue with this strategy, which is that the market will whipsaw you around like crazy.  Choppy markets plus oscillators equals fewer profits and more commissions.

For this reason, I give the cross of the 0 line an F.

#2 – Saucer Strategy

The saucer strategy received its name because it resembles that of a saucer.  The setup consists of three histograms for both long and short entries.

Long Setup

1. Awesome Oscillator is above 0
2. There are two consecutive red histograms
3. The second red histogram is shorter than the first
4. The third histogram is green
5. Trader buys the fourth candlestick on the open

Short Setup

1. Awesome Oscillator is below 0
2. There are two consecutive green histograms
3. The second green histogram is shorter than the first
4. The third histogram is red
5. Trader shorts the fourth candlestick on the open

Without going into too much detail, this sounds like a basic 3 candlestick reversal pattern that continues in the direction of the primary trend.

Awesome Oscillator Saucer Strategy

In the above example, AMGN experienced a saucer setup and a long entry was executed.  The stock drifted higher; however, I have noticed from glancing at a number of charts, the buy and sell saucer signals generally come after a little pop. If you trade the saucer strategy, you have to realize you are not buying the weakness, so you may get a high tick or two when day trading.

The saucer strategy is slightly better than the 0 cross, because it requires a specific formation across three histograms.  Naturally, this is a tougher setup to locate on the chart.

However, you can find this pattern when day trading literally dozens of times throughout the day.

I get that we are attempting to locate a continuation in the trend after a minor breather in the direction of the primary trend, but again the setup is just too simple.  It doesn’t account for trend lines or the larger formation in play.

Due to the number of potential saucer signals and the lack of context to the bigger trend, I am giving the saucer strategy a D.

#3 – Twin Peaks

Now this is not the restaurant for all you chicken wing and brew fans out there.

This is a basic strategy, which looks for a double bottom in the awesome oscillator.

Bullish Twin Peaks

1. Awesome oscillator is below 0
2. There are two swing lows of the awesome oscillator and the second low is higher than the first
3. The histogram after the second low is green

Twin Peaks

Bearish Twin Peaks

1. Awesome oscillator is above 0
2. There are two swing highs of the awesome oscillator and the second high is lower than the first
3. The histogram after the second peak is red

Bearish Twin Peaks Example

As you have probably already guessed, of the three most common awesome oscillator strategies, I vote this one the highest.  Reason being, the twin peaks strategy accounts for the current setup of the stock.  The twin peaks is also a contrarian strategy as you are entering short positions when the indicator is above 0 and buying when below 0.

Therefore, the verdict is in and I am giving the twin peaks strategy a solid C+.

#4 – Bonus Strategy

You will not find this strategy anywhere on the web, so don’t waste your time looking for it.

Going back to the crossing of the 0 line, what if we could refine that a little to allow us to filter out false signals, as well as buy or short prior to the actual cross of the 0 line.

This approach would keep us out of choppy markets and allow us to reap the gains that come before waiting on confirmation from a break of the 0 line.

I am going to coin the setup as the Awesome Oscillator (AO) Trendline Cross

Long Setup – AO Trendline Cross

1. Awesome Oscillator has two swing highs above the 0 line
2. Draw a trendline connecting the two swing highs down through the 0 line
3. Buy a break of the trendline

AO Trendline Cross

As you can see in the above example, by opening a position on the break of the trendline prior to the cross above the 0 line, you are able to eat more of the gains.

The other point to note is that the downward sloping line requires two swing points of the AO oscillator and the second swing point needs to be low enough to create the downward trendline.

Bearish Setup – AO Trendline Cross

1. Awesome Oscillator has two swing lows below the 0 line
2. Draw a trendline connecting the two swing lows up through the 0 line
3. Sell Short a break of the trendline

Bearish AO Trendline Cross

In this example the cross down through the uptrend line happened at the same time there was a cross of the 0 line by the AO indicator.  After the break, the stock quickly went lower heading into the 11 am time frame.

In Summary

The most popular awesome oscillator trading strategies aren’t that great, but of the three, the twin peaks is the best.  However, after reading this article I hope you will go out and evangelize the AO Trendline Cross to the masses.

Much Success,

Al

The post Top 4 Awesome Oscillator Day Trading Strategies appeared first on - Tradingsim.

I am a self-proclaimed ATR fanatic, yet I have not explored Keltner Channels.  The Keltner Channel is a lagging on-chart indicator that uses a combination of exponential moving averages and the Average True Range (ATR) as inputs.  Unlike Bollinger Bands, which uses standard deviations to calculate the width of the channel, Keltner Channels uses the exponential moving average and a multiplier on the ATR to determine the upper and lower bands.

I’m not as scientific as my other trader brethren are, so I’m not going to get into the details of the Keltner Channel formula, but rather will show you the inputs of the Keltner Channel.

The Keltner Channel indicator uses two inputs to configure the indicator.  The first is the length of the exponential moving average and the second is the multiplier you would like to factor in with the ATR.

Keltner Channel Inputs

A good rule of thumb is the longer the length of the exponential moving average, the greater the lag on the indicator.  Lastly, the higher the multiplier, the greater the width of the Keltner Channel.

You should remember to consider these two points when defining your Keltner Channel trading strategy.

If you want more of an understanding around the actual formula for the Keltner Channels, please visit this Wikipedia article.

Now, I could go on and on about how Linda Raschke tweaked Mr. Chester Keltner’s formula and yet the indicator is still called Keltner Channels, but I would rather dive into the charts of comparing the Keltner Bands to Bollinger Bands.

Again, if you are looking for more technical articles on the two indicators, there are tons of posts on the web.  I figured I would just stick to the comparison and leave the number crunching up to the mathematicians.

With that said, let’s dive into our first working example.  Just to be clear we are using the default settings for both the Keltner Channels and Bollinger Bands found in most trading platforms, which is 20 periods.

Example #1 – Riding the Trend

In the below chart example, we are reviewing a 5-minute chart of Ford with the default Keltner Channel settings of 20, 1 and the default settings for the Bollinger Bands.

You will notice on first glance at the chart that the channel is much tighter on the Keltner Channel.

Keltner Channel vs Bollinger Bands – Example 1

In this particular example, it was much clearer to me using the Keltner Channel that Ford was done once it hit its peak. If you zoom in on the example, you can see that there were two green bars and one red bar that were completely outside of the envelopes.  Once the second candle closed below the low of the preceding red candlestick and inside of the envelopes, Ford was done.

Now, if you look at the exact same chart, but with the Bollinger Bands, the action was neatly inside of the envelopes, so as a trader you have a tougher time identifying when a stock is going to breakdown.

If you are day trading with the Keltner Channel, having the ability to quickly notice when a trend can be changing is huge.

Therefore, in the example of riding the trend and knowing exactly when to get off the bus, I’m going to say Keltner 1, Bollinger Bands 0.

Example #2 – Strongly Trending Stocks

Keltner Channel vs Bollinger Bands – Example 2

For those of you wondering what is the difference between this example and riding the trend, it really comes down to the impulsiveness of the move.  As you can see in the above chart, the price action for the most part stayed completely outside of the Keltner Channel.  In our first example, the price movement wasn’t as extreme.

Okay, back to the second example, JDST went on a run that we all would love to partake in on a regular basis.  The question comes down to which indicator would have me in sooner and allow me to ride the impulsive move higher?

Without a doubt, the Keltner Channels made it very clear when JDST started breaking out.  Once the move started, I would have to say that both the Keltner Channels and Bollinger Bands did a great job allowing the trend to develop.

Due to the early entry on the run up, I have to give round 2 to the Keltner Channels.  Our score now stands at Keltner Channels 2, Bollinger Bands 0.

Just a side note, assuming you are day trading, then the major gap down the next day would not apply because you would have closed your position.

Example #3 – Late Day Breakout

The late day breakout is the bane of my existence.  I spent 20 months chasing these late day bloomers before finally realizing this wasn’t my calling.  In the below example, we will dig into whether the Keltner Channels or Bollinger Bands can better detect when a stock is beginning to trend late in the day.

Keltner Channel vs Bollinger Band – Example 3

As you can see, UAL was trending sharply to the downside on the 5-minute chart.  There was a swing low put in around 1:30 pm, and then the stock had a slight retracement before testing the daily low again at 2:25 pm.

This is where I would lock up, as I would be forced to make a decision.  The volume of course would be light as we were in the early afternoon, yet there is a new low.

Well, the Keltner Channels provides us a nice head start on the move as the candlestick closes completely outside of the Keltner Channel.  Therefore, while the volume and price action may not have been significant, you could clearly tell that the volatility was in play with a close outside of the channel.

Now as we look over at the Bollinger Band example, the stock was still nicely sitting inside of the bands, albeit riding the bands.

For this example, I have to go with the Keltner Channel, because I will always go with outside of the bands versus riding the bands in terms of strength of trend.

Our score now stands at Keltner Channels 3, Bollinger Bands 0.

Example #4 – Morning Reversal

The morning reversal is another powerful day trading pattern, as stocks will experience sharp snap back moves.

Keltner Channel vs Bollinger Band – Example 4

ALTR experienced a high volume gap up on May 29th.  As I was reviewing the Keltner Channel, I realized the candlesticks were well beyond the upper channel.  So, once ALTR started to give it up, how were you to know it’s time to short or where to exit your long position?

Conversely, as we look at the Bollinger Bands, once the stock comes inside of the bands, you know things are in trouble.

Therefore, in the snap back reversal, Bollinger Bands are more suitable as the indicator is based on standard deviations.  The crazier the action, the wider the Bollinger Bands will expand, which will clearly display the breakdown if the stock starts to give it up.

Our score now stands at Keltner Channels 3, Bollinger Bands 1.

Example #5 – Choppy Stocks

Keltner Channel vs Bollinger Band – Example 5

Choppy markets are a reality of trading whether we like it or not.  So, when it comes down to properly containing the price action, which indicator does a better job of filtering out the noise?

As you can see, the Keltner Channel is more sensitive to the price movements in tight channels, therefore buy and sell signals could be a bit exaggerated.

However, as the Bollinger Bands are calculated using standard deviations, the bands do a much better job of filtering out the noise within a range bound market.

Therefore, for choppy markets, the nod has to go to Bollinger Bands.

Our final score comes in with Keltner Channels 3, Bollinger Bands 2.

In Summary

Each of these price-lagging indicators do a great job for what they are designed to do.

As volatility is baked into the Keltner Channels, the indicator does an awesome job of providing insight into stocks when they are riding the trend, strongly trending higher or breaking out.

Whereas the standard deviation component of Bollinger Bands gives enough of a range between the upper and lower bands to better handle significant gaps that reverse sharply and range bound markets.

At this point, I’m assuming you are wondering which indicator is better and in the true form of a trader, I will say both.

As stated throughout this article, trying to say one indicator is better than another is relative.  It truly comes down to the 5 scenarios you are attempting to trade and your trading goals.

To see how Tradingsim can help improve your trading performance, please visit our homepage to see our latest offerings.

Much Success,

Al

The post 5 Examples of Keltner Channels versus Bollinger Bands appeared first on - Tradingsim.

choppiness indicator

Wouldn’t we all love to know when a stock is trending and when it is in flat territory?

Close your eyes for a second and imagine a world where you know on the first tick that the market is starting to trend.  An indicator that would somehow tell you to ignore all of the head fakes and shakeouts, and only focus on the move that counts.

Sounds too good to be true right?  Well, if you have not figured it out yet, I am trying to downplay the choppiness index a bit, because on first glance of the title, it sounds like it packs a powerful punch.

In this article, I will explore 4 trading strategies you can implement using the choppiness index indicator; however, it does require some work on your end.  Unfortunately, you cannot trade the buy and sell signals blindly, if only it was that easy.

Overview of the Choppiness Index Indicator

How befitting of the choppiness index to be an oscillator.  Funny to think for an indicator that is supposed to dictate choppiness, it too is bound by ranges.

Like many other oscillators, the range for the choppiness index is 0 to 100.  The choppiness index indicator uses a standard look back period of 14 days and takes into account the average true range indicator, price high and price low to determine a percentage value.

To learn more about the choppiness indicator formula, please visit the following link.  For those that follow the Tradingsim blog, you fully understand that I do not claim to be a statistician, so I don’t bog myself down in memorizing formulas.

I try to stick to interpreting the signals provided by these indicators and how well they measure up in the real world.

Inputs for the Choppiness Index Indicator

The input length for the look back period is 14.  Not that interesting if you ask me.  However, when you look at the style inputs, where you define the boundaries for the indicator, things become more intriguing.

choppiness index inputs

Do you notice anything peculiar about the inputs?

Take a hard look and no, it is not the color options.

For my Fibonacci students out there, you will notice that upper and lower limits are set to the 61.8% and 38.2% retracement levels.  In another article related to slow stochastics, I explored the concept of testing out other values to denote overbought and oversold.  Therefore, for me the fact the indicator defaulted to anything other than the standard 80 or 20 was a breath of fresh air.

If the indicator is above 61.8%, then the stock is experiencing a choppy trend; however, if the reading is below 38.2% the stock is beginning to trend.  Therefore, the closer you are to 100, the choppier the market and the closer to 0, the greater the trend.

To be honest, pretty straightforward stuff, but what are the trading strategies we can use with the indicator?  Well, please continue reading on to find out.

4 Trading Strategies for how to use the Choppiness Indicator

#1 – Buy or Sell the Breakout after extreme Choppiness Index Readings

Now, if you take a browse of the articles on the web, they will simply inform you to buy or sell the break of the 38.2% retracement of the choppiness index as the stock is starting to trend.  While this is the basic trigger for the indicator, I think there is more value to this indicator if we dig a little deeper.

For example, when a stock is trending above the 61.8% reading for an extended period of time, this is a sign to you that the market is beyond flat but practically dead.

Therefore, instead of buying or selling the break of the 38.2% retracement, another approach is to wait for a fall back below the 61.8% retracement level to signal a trend is in its infancy.

Let me show you a picture, to further illustrate this point.

choppiness index breakout

Couple of points to note is that the choppiness indicator of course would be best used for gauging a breakout after lunch.  Any of us that have been day trading for any extended period of time have come to respect the flatness of the mid-day trading session.

Therefore, it is critical for this breakout strategy to (1) occur in the late afternoon and (2) have extreme readings on the choppy index for 1 to 2 hours on a 5-minute chart.  This is a sign to you the trader, that when a breakout occurs as the stock is starting to trend, that you may be able to catch some late day fire.

#2 – Ride the Trend using the Choppiness Index Indicator

Beyond identifying when a stock is choppy, the other value add for the choppiness indicator is the ability to stay in a stock when it’s trending.  Placing a slight twist on the readings for the indicator, try applying the below logic when reviewing the charts.

If the choppiness indicator does not print 3 or more readings above the 61.8% retracement, and the stock is in a strong trend, hold on for the ride.

Below are a few illustrations of this setup.

choppiness indicator and trending stocks

choppiness indicator and trending stocks 2

What I like about using this approach, is that you can weed out all of the false readings, as these pullbacks are just noise inside of the context of the primary trend.

The key point to bring home is that you have to develop a solid system for determining when a stock is starting to trend.  If you are unable to consistently identify a trending stock, you will find yourself making trade decisions based on false signals.

#3 Trade within Choppy Markets

This is an obvious strategy for the choppiness index indicator; I just did not want to lead with this approach in our list of strategies.

Honestly, I do not see the value of using the choppiness index indicator to trade choppy markets.  From what I can see of the readings, it is not like you hit the top of a range and therefore volatility should drop off, which should coincide with a subsequent pullback and increase in volatility.

The choppiness indicator is not like an oversold or overbought indicator, so trying to time the moves inside of a tight range could prove a little difficult and may need a little help from a stochastics or Williams R.

Another way of saying this is just because the indicator is at 61.8% does not mean the stock will all of a sudden start trending.  You really need price action like in examples 1 and 2 above to increase the level of certainty provided by the indicator.

Lastly, trading the chop, as I call it, has not served me well over the years.  Not saying that you cannot figure it out, because choppiness may match your personality to the letter.

To further illustrate this point, take a look at the chart below that is in a late day afternoon trading range.  Please tell me if you see a way the indicator can help jump in front of the move.

choppiness indicator and choppy markets

#4 – Walk away from stocks that do not trade nicely with the Choppiness Index Indicator

One item to point out is that some stocks will not adhere to the nice boundaries of 61.8% and 38.2% for the choppiness index indicator.  You will look at some charts and there will be all sorts of false signals above and below the boundaries of the indicator.

This sort of chart action will be very evident on quick glance.  A few breaches of the boundaries does not warrant writing off the indicator; however, if you cannot make heads or tails of it, please do not start modifying the settings to fit each security perfectly.

The reason I say this, is that you are now trying to take an indicator and make it custom for every single stock in the market.  Honestly, that sort of effort just is not worth the time.  If anything, you want to use the fact the stock does not adhere to the boundaries as a reason to filter out the stock from your list of potential candidates.

Trust me; there will be tons of other opportunities.

To further illustrate this point, please tell me if you can get a reading on any of the charts below.

choppiness index false signal

choppiness index false signal 2

In both of these examples, you will notice that the indicator was giving readings all over the place, yet the price action was either coiling or still within the confines of a larger range.

Not that you cannot make money trading these patterns, but it is much easier to focus on the stocks that adhere to the boundaries, versus trying to solve for the 20% that do not.

In Summary

True to its name, the choppiness index indicator does help identify when a stock is experiencing volatility; however, trading choppy markets is not where the indicator excels.  The strength in the indicator is best displayed when used as a confirmation that a stock is starting to trend or breaking out.

A simple, yet effective way to validate signs from the choppiness index indicator is to see if volume accompanies the move.  Where there is volume, there is likely something brewing.

Lastly, just to reiterate the point from strategy number 4, if you find yourself having to customize any indicator, you are trying to fit a square peg into a round hole.

The same way you do not force trades, you should not force indicators to fit stocks or markets that trade differently.

To see how we can better help you understand the choppiness index indicator, please take a look at our homepage.

Much Success,

Al

The post How to Trade using the Choppiness Index Indicator appeared first on - Tradingsim.

net volume indicator

I quite frequently perform research on technical indicators and to be honest, net volume never peaked my interest.  Therefore, I have decided to explore in this article why I am not enamored with the indicator.

Unlike other indicators discussed on Tradingsim, net volume is easy to calculate.  If the stock finishes up for the period, then the net volume is positive. If the stock is down from the previous close, then the net volume is negative.

In this article I will cover the 5 reasons I think net volume is my least favorite of volume indicators.

#1 – Too Simple

I am all for simplifying my life, starting with my trading indicators.  However, there needs to be a little more to the net volume indicator.  For starters, the indicator does not factor in a look back period like the volume weighted moving average or cumulative figures like the on balance volume (OBV) indicator.

The net volume simply looks at the current volume statistics for one candlestick.  Now you could be thinking, well it is the trader’s responsibility to determine the look back period and this is a true statement.

But, what about the crazy idea that your indicator should provide a consistent way of analyzing the market and not totally leaving it up to you to interpret.

net volume indicator look back period

As you can see in the above chart, what is the net volume telling us?  You can see the spikes higher on the lows set, but the stock is clearly in a downtrend, so no surprises there.

Again, how far do you look back?  This performance period will ultimately determine how you should interpret the data and without that my friend, the indicator is way too subjective.

#2 – Positive versus Negative Readings

When you read articles and books on the net volume, there is a lot of mention about gauging if there is more positive or negative readings, which could implicate the strength of the trend.

This is a faulty assumption, as you could have a stock float lower or higher with low volume.  Therefore, the net volume could continuously print a positive value on the indicator as a stock is rising, but this is no indication of the strength of the trend.

The positive reading could represent the fact the strong hands are letting the small fish drive up the stock, only to enter a significant sell order at a loftier price.

To further illustrate this point, let’s take a look at the charts.

net volume bigger view

Notice how after the push higher into the noon or lunch time reversal zone, the stock then begins to trade lower.  Next, notice how the volume on the downside is much lighter, yet the stock continued lower for over 2 hours.

So, the net volume indicator showed a ton of low volume negative readings, but did it mean anything?  Did price all of a sudden stop because the volume was no?  No, it was a slow bleed down if you bought in right around noon.

#3 – Lacks Predictive Capabilities

The net volume is a snap shot view indicator, candlestick by candlestick.  Now you can make general assumptions that the stock will continue higher if the trend is up, but isn’t that something you can assess with the price chart?

Meaning, how does the net volume further help you to identify the true nature of a stock’s trend or pending breakout?

If anything, the net volume can be used as a lagging indicator to validate price action.  Therefore, if you see a breakout and the net volume is high on the upside, then this may lead you to believe the trend will continue.

However, the net volume indicator in no way will tell you that a stock is somehow overbought or oversold.   If you are looking for this level of forecasting capabilities within the net volume, you will be sadly disappointed.

#4 – Visually Hard to Interpret

When you look out into the world, everything is in 3 dimensions.  You are also looking at the world right side up.

What throws me off about the net volume indicator is the fact the histogram or columns (depending on your settings) will print above and below the 0 line.  I find it extremely difficult to then assess the trend as the spikes of the net volume indicator could be on opposite sides of the plane.

To see the indicator print side-by-side, makes it easier to assess the strength of the volume relative to each bar.  This becomes increasingly challenging to assess when there are volume spikes.

net volume indicator missing bars

I totally get the fact the bars are there, but it just feels like something is missing when the bars don’t print next to each other.  Having this visual break in data, is almost like trying to pick a book back up again after you haven’t read a page in weeks.  You know you are picking up where you left off; the story just feels fresh because you didn’t read it every day.

#5 – Plain Volume is Just Better

In life, some things are better just left alone.  The volume indicator by itself provides more than enough information to traders.  I get all of the information provided by the net volume and I also can see the indicator more clearly on the chart.

net volume versus volume

When I look at the above example, it’s practically impossible to see the net volume indicator readings.  Not that the volume indicator is a cake walk either, but I can at least make out the color of the volume bars and the wider width makes it easier to see as well.

In Summary

I know this article was pretty tough on the net volume indicator, but we as traders need to be more critical of our tools.  You need to constantly review and challenge the need for every item on your chart.

If I am still unable to sway you away from the net volume indicator, feel free to visit our homepage to see how you can practice using the indicator on real market data.

Good Luck Trading,

Al

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Overview of Elder’s Force Index (EFI)

You can never call Alexander Elder a humble guy as he decided that the best name for his indicator would be that of his own last name.

I can however appreciate the fact that Alexander believed in his own analysis so much, that he was willing to associate his own name with his findings.

The Elder’s Force Index is an oscillator, which attempts to identify the force or strength of a move. Elder felt that this was best calculated by factoring in a stock’s volume and comparing the current period close to the previous period close.

This tight comparison allows the indicator to perform a bar-by-bar assessment of a stock’s performance.

Elder’s Force Index Formula

The EFI formula is about as straight forward as you can get with technical analysis these days.

(Today’s Close – Yesterday’s Close) * Volume = Elder’s Force Index

As you can imagine, if we are talking about a stock with high volume, the EFI readings will be pretty high. Therefore, when comparing different charts, a higher or lower EFI value does not mean one stock has more force than another. Remember, the reading is specific to each stock as there is no upper or lower boundary on the Elder’s Force Index like other oscillators.

Next, you need to decide on the look back period for the indicator, which will give you the average over a set number of EFI readings. The default value used by most trading platforms is 13, which is what we will be using for our chart illustrations.

length of elder’s force index

Day Trading Strategies using the Elder’s Force Index

When you read about the EFI indicator on the web and in books, you will find the standard trading strategies around waiting for the indicator to cross above or below the 0 line.

Another common strategy is to look at divergence of the EFI with the current price trend to gauge when a stock is likely to have a counter move, as the internals of the move are shaky.

These are all your plain vanilla trading strategies, which add some value. However, I will be covering some uncommon strategies that you can explore for how to use the EFI when day trading, which will hopefully give you an edge.

Strategy # 1 – Extreme Readings

Since the EFI is tied to volume, when you have volume surges the indicator will spike violently. As day traders, we make the most money trading during volatile times.

To this point, the setup requires that you wait for the indicator to produce an extreme reading to either the up or down side.  Again, these high readings just mean you have had sharp price movement with increased volume.

Next, you want to see a reversal from the extreme reading and then the EFI shoot back to a recent high or low area.  Please look at the below illustration to help with this point.

EFI Extreme Readings

I’m guessing you are wondering what happened next?  Well, let’s take a look.

Much Higher

GE managed to make a significant run after the fake out.  Notice how the most recent EFI reading is so much higher than the previous gap and reversal period that the previous extreme reading now looks like a bump in the road.

Again, the Elder’s Force Index has no ceiling, so the indicator can run if given the right circumstances.

Recap of Strategy # 1 – Extreme Readings

1. Look for an extreme high or low reading
2. The EFI needs to quickly reverse back to a recent peak or trough
3. Buy or sell the stock once it reaches the recent peak or trough

Strategy # 2 – Sell the pullback to the trend line

This strategy is a bit involved, so stay with me.  I’m pretty sure you are all familiar with the concept of drawing trend lines on indicators.  Funny enough, you can see support and resistance zones the same way the show up on price charts when using the EFI.

Since the Elder’s Force Index can trend in one direction without boundaries, the EFI will often produce longer-term trends.   As a day trader, when you are looking for a midday setup, which requires identifying longer patterns, as you do not have the volatility present in the morning, the EFI can provide insight into a break in trend.

Trend lines on the EFI

If you were in the stock and were only looking at the price action, you really had no way of knowing the fun ride was coming to an end.  However, the Elder’s Force Index had a break below a trend line, which was an early indication that the force or strength behind the move was dissipating.

The same as in price action, once the EFI back tested the uptrend line, the price went flat.  Longs that entered the position in the morning could have used this as an opportunity to exit their position and book profits.

Recap of Strategy # 2 – Sell the pullback to the trend line

1. Stock is on a run for more than a few hours.  This will produce a longer up or down trend for the EFI
2. Exit existing positions on a break of the trend line
3. If you are looking to go counter to the trend, wait for a back test of the trend line to open a position

In Summary

I just spent the last 30 minutes looking for additional creative strategies for how to trade the EFI and I kept coming up with blanks.  The standard divergence analysis just isn’t enough for me these days.

Based on the above two strategies, take a look at your existing systems and see if there is anything there you can use in your trading toolkit.

The key thing to remember is that you want to user the Elder’s Force Index to really gauge when a stock or trend is moving sharply.  The last thing you want to do is try to use the indicator when the market if flat.

Seeing that the indicator literally has force in its name, you probably want to make sure you use the market to again assess strong trends.

Good Luck Trading,

Al

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What is the Ichimoku Cloud?

The Ichimoku Cloud, also known as Ichimoku Kino Hyo is a technical indicator, which consists of five moving averages and a “cloud” formed by two of the averages. The default parameters of Ichimoku Cloud are 9, 26, 52, but these parameters are configurable based on the preferences of the trader. Since the Ichimoku Cloud provides a number of trend signals, some traders consider the Ichimoku Cloud the only technical indicator required on the chart.

The Ichimoku Cloud indicator on first glance can feel overwhelming to traders not familiar with the indicator.

Look at the image below:

LinkedIn Price Chart

This is a normal H1 chart showing the price action of LinkedIn during the month of September 2015. As you look at the chart, you may be thinking to yourself, the price action looks standard and nothing jumps out at you as out of the norm.

Now we add the Ichimoku Cloud to our LinkedIn chart and we get the following picture:

Ichimoku Cloud - LinkedIn

“What just happened”, is the initial reaction of traders not familiar with the Ichimoku Cloud. To the untrained eye, the indicator looks like total chaos on the chart, with lines crossing each other without any clear purpose or trajectory.  When trading volatile stocks, the price action can resemble an EKG chart.

I can assure you that the Ichimoku Cloud is the furthest thing from chaos and is quite easy to understand after you become accustomed to the settings.  To this point, in this article we hope to improve your understanding of the indicator and provide a simple trading strategy you can apply to your trading toolkit.

Components of the Ichimoku Cloud

After panicking about the number of lines on your chart, let’s take a closer look at the inputs to the Ichimoku Cloud. What do we see first? Five lines: one red, one blue, one green, two orange and a shaded area in-between.

Now, let’s define each of these lines to further understand their purpose.  Just to reiterate a point made earlier in the article, each line is a moving average. Therefore, you should look at the Ichimoku Cloud indicator as five moving averages and nothing more.  If you are not familiar with moving averages, it is one of the easiest technical indicators to master, so no worries on that front.  To further dive into the makeup of the Ichimoku Cloud, the below content outlines the moving averages and how the cloud is formed.

• Tenkan Sen (red line) – this line is a moving average, which displays the middle value of the highest and lowest points on the chart over the last 9 periods.

• Kijun Sen (blue line) – it has the same function as the Tenkan Sen (red line), with the difference that the periods taken into consideration are 26. As you have probably noticed, the Kijun Sen (blue line) is slightly slower than the Tenkan Sen (red line) and the reason for that is the larger number of periods. Since the moving average takes more periods, it takes a longer period of time to “react” in a meaningful way.

• Chinoku Span (green line) – this line represents the current price, but it is shifted to the left by 26 periods. If you look at the image above, you will realize that the green line is 100% identical with the price movement.

• Senkou Span or “The Cloud” (orange lines) – since people call this span “The Cloud”, we decided to color its inside with a clear white color, so it will really look like a cloud. The cloud consists of two lines, which we have colored orange.
  1. The first line of the Senkou Span is the current average of the highs and the lows of the Tenkan Sen (red line) and Kijun Sen (blue line), displaced 26 periods to the right (leading).
  2. The second line displays the middle point between the highest point and the lowest point on the chart for 52 periods. This line is also displaced with 26 periods to the right, as the other line of the cloud.
  3. The cloud is the area on the chart, which is comprised of the interactions of the two aforementioned averages of the Senkou Span. The cloud also represents the furthest support/resistance level, where our trading position is recommended.

So, after explaining the components of the Ichimoku Cloud, we hope things are a little clearer for you the reader!  Well, not really, but things have to be a little involved if it is the only indicator required on the chart.

How to use the Ichimoku Cloud indicator when trading?

Today we are going to discuss an Ichimoku Cloud trading system, which does not require any additional indicators on the chart. This Ichimoku trading strategy is applicable for every trading instrument and timeframe.

Placing a trade when the price closes outside the cloud

This method could also be coined the Ichimoku Breakout Trading Strategy. This is because the trade trigger occurs at the point the price breaks through the cloud.  First, you open your trade in the direction of the respective breakout and then hold the position until the security breaches the Kijun Sen (blue line) on a closing basis.

To illustrate the breakout strategy, we will review a real-market example of Intel from September and October 2015.

Ichimoku Cloud Breakout Strategy

As you can see, early on in 2015 the price action was in a sideways channel. Furthermore, the cloud itself was flat to down during this same time period.

When analyzing the price action for potential trade entries, we walked through the following sequence of events:

First, the price of Intel goes through the Tenkan Sen (red) and Kijun Sen (blue) in a bullish fashion. Although these signals are bullish, we still need additional confirmation in order to take a long position.

Second, the price of Intel breaks through the cloud in a bullish fashion as well.  We open a long position (first green circle) and hope for the best!

Third, Intel had a few unsuccessful attempts to break the Kijun Sen (blue), but lucky for us, the price never breaks on a closing basis and the upward trend remains intact.

Fourth, the price breaks the Kijun Sen in a bearish direction and closes below the Kijun Sen. This price action means we need to exit our position and begin seeking other opportunities.

In the next 4 hours, the price does another bullish break through the Tenkan Sen (red) and the Kijun Sen (blue). At the same time, Intel also breaks the cloud in a bullish direction once again. Opportunity after opportunity – great! We take another long position based on the bullish price action. On this run up, Intel unfortunately broke the Kijun Sen (blue) on a closing basis; therefore, we exited our long position with a decent profit.

These are two trading examples of how this strategy could be successfully implemented. Note that in the second case, the signal to exit the position wasn’t very strong, but should still be honored.

Although the market continues to move in our favor after we exited the position, there are many cases where the sell signal could lead to further losses. Therefore, the better alternative is to always follow your trading rules and exit your positions when required.

The results are the following:

• 2 successful bullish positions
• 0 fails
• A total profit of 318 bullish pips

Now, let’s try the same strategy on another trading instrument! Below you will see an image displaying the M10 chart of Apple Inc.:

Ichimoku Cloud Apple Example

In this example, our Ichimoku Cloud breakout strategy fails twice, but also succeeds twice.

Similar to our earlier Intel example, Apple starts with sideways movement. The price has been range bound and the cloud has been flat – presenting no opportunities to open a position. Then suddenly…

• We see the price breaking the Tenkan Sen (red), Kijun Sen (blue) and the cloud in a bullish fashion. We go long according to our Ichimoku Cloud breakout strategy. Unfortunately, shortly after the breakout, the price records a rapid bearish candle, which results in Apple closing below the Kijun Sen line (blue). We close our position with a loss equal to 19 pips.

• Fortunately, with the next two candles comes our second chance, as the price breaks through the cloud, Tenkan Sen (red) and Kijun Sen (blue) in a bullish fashion. So, we open our new long position. The market starts moving in our favor and we enjoy this nice and steady bullish movement. After a few hours, the price of Apple breaks the blue Kijun Sen line and closes below. We exit our position with a profit equal to 144 pips.

• After four hours, we take our third bullish position on another breakout. After two hours of hesitation, Apple’s price closes below the Kijun Sen (blue). We follow our exit strategy and are forced to close our position with a loss of 43 pips.

• Our fourth example is where the Ichimoku Cloud can really help you capture the big wins. As you can see on the chart, the bullish trend is really strong and has yet to break the Kijun Sen (blue).  Therefore, our fourth position is still open and the result for now is a profit of 412 pips. Wohoo!

Let’s now revise the results of our second trading example:

• 4 bullish positions
• 2 successful
• 2 fails
• Loss = 62 pips
• Profit = 556 pips
• Balance = 556 – 62 = 494 pips profit

Not bad eh?

In the last chart example, we provided examples of unsuccessful traders on purpose.  We did this because it is necessary to illustrate that the Ichimoku Cloud indicator is not perfect and there will be bumps in the road.

Any who, when trading with the Ichimoku Cloud, you should be extremely careful not to ignore a signal and it is highly recommended to always monitor your open positions – do not walk away from the computer!

The reason is that you could miss an exit signal and a winner could just as easily turn into a losing trade.  Remember, never give up on your trading strategy principles and never compromise any of your rules for profits.

In Summary

• The Ichimoku Cloud is a trading indicator consisting of 5 moving averages and a “Cloud”
• The default Ichimoku settings are 2, 26, 52
• The names of the Ichimoku components are Tenkan Sen, Kijun Sen, Chinoku Span and Senkou Span (The Cloud)
• The Chinoku Span is displaced backwards (26 periods) - it is lagging
• The Cloud is displaced forwards (26 periods) – it is leading
• The Ichimoku Cloud could be used by itself for trading
• The Ichimoku Cloud is not as complicated as it looks
• The Ichimoku Cloud is fully customizable

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As stated in its name, the volume weighted moving average (VWMA) is similar to the simple moving average; however, the VWMA places more emphasis on the volume recorded for each period.  A period is defined as the time interval preferred by the respective trader (i.e, 5, 15, 30).

Therefore, if you place a 20-period simple moving average (SMA) on your chart and at the same time, a 20-period volume weighted moving average, you will see that they pretty much follow the same trajectory.  However, on further review, you will notice the averages do not mirror each other exactly.

The reason for this discrepancy, as we previously stated is the VWMA emphasizes volume, while the SMA only factors the average of the closing price per period.

VWMA versus SMA

The above chart is of Microsoft from September 25, 2015. On the chart, we have placed a 20-period simple moving average (red) and a 20-period volume weighted moving average (blue). At the bottom of the chart, you will also see the volume indicator, which we will use in order to demonstrate how the VWMA responds to volume. In the green circles on the chart and on the volume indicator, we have highlighted the periods of high volume. Notice, that wherever we have a big volume candlestick, the blue volume weighted moving average starts moving away from the trajectory of the red simple moving average. Then, whenever we have lower market volumes, the red simple moving average and the blue volume weighted moving average are very close in value.

Can you see the difference now?

What is the Volume Weighted Moving Average good for and what signals can we get out of it?

The VWMA has the ability to help discover emerging trends, identify existing ones and signal the end of a move.

#1 - Discovering Emerging Trends

If the volume weighted moving average switches below the simple moving average, this implies a bearish move is on the horizon. This could lead to a weakening in the bullish trend or an outright reversal.  If the price is able to break through both the VWMA and the SMA a bearish trend is confirmed and a short position can be initiated.

Conversely, if the volume weighted moving average moves above the simple moving average, a bullish trend change is likely around the corner.  Once the price is able to break both the VWMA and the SMA to the upside, one can open a long position.

The below chart illustrates these trade setups.

Breakout through VWMA and SMA

This is a M2 chart of Deutsche Bank from August 5, 2015. On the chart, I am using the 30 SMA and 30 VWMA. As you see, after the market was range bound for a period of time, we notice an increase in the distance between the volume weighted moving average and the simple moving average. At the same time, the price breaks out of the range, which gives us an additional bullish signal. We go long with the second bullish candle after the breakout of the range and we enjoy the impulsive move higher.

#2 - Identifying Current Tends

Here we have a simple rule, if our volume weighted moving average is between the chart and the simple moving average, then we have a signal for a trending market. Note that sometimes the volume weighted moving average will test the simple moving average as a support and resistance, depending on the primary direction of the security. These tests can be considered as an implication of a potential trend reversal. Take a look below:

Trend Folllowing and VWMA

This is a M5 chart of Google from July 22^nd, 23^rd and 24^th from 2015. We use the same 30 SMA and 30 VWMA as in the previous chart example.

In the green circle, you will see the moment where the price breaks the 30 SMA and the 30 VWMA in a bearish direction. At the same time, the blue VWMA further separates from the SMA and is between the SMA and the candlesticks. This is a clear “short it” signal. If you check a half an hour later, you will see that the blue VWMA is still below the red SMA, which means that the bearish trend is still intact.

The arrows show the moments, where the VWMA provided a signal for the continuation of the bearish trend.  If we were to go short at any of these points, we would not be disappointed. The last red arrow shows us the moment when the bearish trend shows signs of slowing down as the VWMA and SMA begin to hug one another.

#3 - Detecting the End of a Trend

This signal is pretty much the same as when we had to discover emerging trends. The difference is we are looking for a contrary signal to the primary trend. For example, you have taken a long position and you notice a tightening in the distance between the VWMA and the SMA. This is the moment where you might want to consider the option to get out of the market and to collect your profits.

Trend Reversal and VWMA

The above chart is of Facebook from July 16^th – 22^nd.   Facebook begins the week with a strong gap up with high volume. After the gap, we have a solid bullish candle and a large distance between the 30-period VWMA and the 30-period SMA. Therefore, we go long with the closing of the first bullish candle. Facebook keeps increasing until the volume drops and the market enters a correction phase. This is when the blue VWMA interacts with the red SMA and we get a “caution” signal. Fortunately, with the next candle, the trading volume increases and the VWMA moves again above the SMA.

Still in the game! Bullish we are!

We hold our position for about 20 more periods and we nearly double in our long position. Then, the blue VWMA switches below the red SMA (red circle) and refuses to go above for about 8-9 periods. We believe 3-4 periods of waiting are enough in order to realize that this is the right moment to close our position. After we exit our position, the price of Facebook starts to rollover and eventually breaks down through the moving averages. Exiting Facebook at the right time brought us a profit of about 55 bullish pips! Viva les Market Volumes!

#4 - The VWMA Divergence

Yes, that is correct! You can discover divergences between the volume weighted moving average and the general chart. You will say, “How could this be possible? This is not an Oscillator!”

Nevertheless, the volume weighted moving average could be in a divergence with the chart, and the secret is in the second moving average we advised you to use. When you have for example a simple moving average in addition to the chart, the volume weighted moving average will switch above and below your simple moving average depending on trade volume. Therefore, whenever the volume weighted moving average is closer to the chart than the simple moving average, we can say that the market is trending and volumes are increasing! Still not getting “the divergence”, let’s walk through a chart example.

Divergence and VWMA

Above is an M15 chart of Microsoft from the first seven days of October, 2015. As you see, after a strong bullish movement, the blue volume weighted moving average moves below the red simple moving average. Therefore, we expect to see a decrease on the chart. Although the bullish movement loses its intensity, the price of Microsoft still manages to close higher for a few candlesticks.  This all happens while the blue volume weighted moving average stays beneath the red simple moving average, thanks to the bigger trading volumes shown on the bottom of the chart. This is a bearish divergence, which you could use as an opportunity to go short.

Divergence and VWMA - 2

KABOOM! The result is 100 bearish pips and a successfully traded bearish divergence between the chart and your 20-period volume weighted moving average. Note, the high bearish volumes at the bottom, which appeared right after the divergence and right before the drop of the price. These bearish volumes also confirm the authenticity of our bearish divergence.

In Summary

In conclusion, we could say that although the volume weighted moving average looks complicated at times, it is not!

If you have difficulties understanding the VWMA, just open a volume indicator at the bottom of your chart. It will give you a better picture explaining the “chaotic” movement of the VWMA in comparison to the SMA.

• The volume weighted moving average places a greater emphasis on periods with higher market volume.
• The volume weighted moving average is a better indicator when combined with another trading instrument for trading signals.
• The simple moving average is a great tool to combine the volume weighted moving average.
• VWMA can provide the following signals
• A trend is coming!
• A trend it is!
• The trend is ending!
• The VWMA can also identify divergence in the market

The post 4 Simple Ways to Trade with the Volume Weighted Moving Average (VWMA) appeared first on - Tradingsim.

Just like regular exchange traded funds, a leveraged ETF can get you exposure to a particular sector, but as the name suggests, it uses built in leverage to maximize or minimize the exposure, depending on the directional movement of the market. Hence, before you endeavor to trade leveraged ETFs, please remember that it can be a double edged sword.

If you are new to leveraged exchange traded funds (ETFs), and still wondering what is a leveraged etf, you should first click here and familiarize yourself with what leveraged ETFs are and learn about how this extraordinary trading instrument works.

Finished reading? Great! If you have read the overview regarding  leveraged ETFs, you should understand why trading leveraged ETFs in the long-term doesn’t work as well as trading these in the short-term.

So, in my opinion, what type of strategy would work better in the short term? The obvious answer is technical trading strategies. This is because changes in fundamentals can take days, or even weeks, to have any noticeable effects on the market. This is especially true, when you are analyzing the entire sector of an ETF based on macroeconomic factors.

Tip # 1 – Know Your Leveraged ETF

“If you know your enemies and know yourself, you will not be imperiled in a hundred battles... if you do not know your enemies nor yourself, you will be imperiled in every single battle.” - Sun Tzu

Well, you are not going to war, but it pays to understand the underlying securities that make up the leveraged ETF. Some commodities and sectors are extremely volatile compared to others, and trading a triple leveraged ETF based on that commodity or industry can completely destroy your entire day’s profits in minutes.

Figure 1: The Volatility of VelocityShares 3X Long Crude ETN (UWTI) Can Be Very High

For example, according to Google Finance, the beta of a triple leveraged oil ETF like the VelocityShares 3X Long Crude ETN (UWTI) is 2.18.

Figure 2: The Volatility of Direxion Daily Gold Miners Bull 3X ETF (NUGT) is Much Lower

On the other hand, the beta of a leveraged gold ETF like the Direxion Daily Gold Miners Bull 3X ETF (NUGT) is only 0.54.

So, you should individually assess the leveraged ETF risk. If you trade UWTI and NUGT with the same trend trading strategy, it would be suicidal. Because NUGT price tends to have a more range bound price action, while the UWTI would likely establish a trend during the trading day.

Now that you know what to look for in a leveraged ETF to classify it as suitable for trend trading, visit ETFdb’s leveraged etf list and cross check the beta of the leverage ETF in order to cherry pick the most volatile ones. You should remember that a beta above 1 indicates a higher volatility compared to the market, whereas a beta below 1 indicates that it has a lower volatility compared to the market.

Tip # 2 – Trading Leveraged ETF Breakouts with Directional Movement Index

Now that you understand why it is better to trend trade volatile leveraged etfs, like an oil leveraged etf, let's discuss a Directional Movement Index strategy that you can apply to trade leveraged oil etf breakouts.

Figure 3: Directional Movement Index Above Level 20 Signals Potential Start of a New Trend

If you are not familiar with any of the Directional Movement Index strategies, here is a quick tip: professional day traders often consider that the leveraged etf instrument is about to start a short-term trend whenever the average directional movement (ADX is the red line on the DMI chart) climbs above 20. However, a lot of traders are more conservative and only consider a reading above 25 to be an indication of a potential trend.

Depending on your own risk appetite, you can decide which level you would like to watch. But, the principle would remain pretty much the same.

When you find that the average line of the Directional Movement Index is climbing above level 20 (or level 25), and the price of the leveraged ETF closed above a significant resistance level, it should be considered as a valid breakout.

In figure 3, the UWTI price was trading between $8.50 and $8.61, while the ADX value climbed above level 20. It indicated that this could be the start of an uptrend. If you find the market in this kind of situation, you should place a market order to buy the leveraged etf the moment the price climbed above the high of the range and closes above it.

Tip # 3 – Trend Trading  Leveraged ETFs with Directional Movement Index

As we discussed earlier, the reason you should pick highly volatile leveraged ETFs for short-term day trading is that these tend to trend a lot. By applying the Directional Movement Index indicator, you can easily capture the bulk of the short-term trends of leveraged ETFs.

Even if you already have a long position, the Directional Movement Index can help you to scale-in and increase your exposure in the sector of the leveraged ETF.

Figure 4: When ADX is Rising, There is a High Probability That the Trend Will Continue

A rising average directional index (ADX) indicates that the underlying trend is gaining strength. Hence, when you find the ADX of the leveraged ETF is gaining momentum, and the line is going up, you should look for opportunities to increase your exposure.

There are a number of ways you can scale-in or add additional positions to your trade. For example, by combining other technical indicators with the Directional Movement Index  signal, such as moving average crossovers or even price action, to scale-in to a position.

In figure 4, after breaking out of the consolidation, the Directional Movement Index of the UWTI leveraged ETF continued to rise and went above level 40. When the Directional Movement Index value approaches level 40, you should consider that the leveraged ETF is in a strong trend and look for signals to scale-in. On this occasion, the UWTI price formed a large inside bar (IB) after the breakout.

Along with the rising Directional Movement Index, the formation of the inside bar signaled a trend continuation. You could have easily entered an additional long position when the UWTI price penetrated the high of the inside bar and increased your exposure as a part of your leveraged investment strategy.

Tip # 4 – Using Directional Movement Index for Trading a Range Bound Leveraged ETF

Figure 5: Using Directional Movement Index for Trading Range Bound ProShares Ultra S&P 500 (SSO)

When you find a leveraged ETF is trading within a range and the Directional Movement Index is lurking below 20, you can be certain that the likelihood of a breakout is slim. Hence, you can easily buy near the support and exit the position near resistance and make some easy money in the process.

In the trade example above (figure 5), you can see that the ProShares Ultra S&P 500 (SSO) formed an inside bar around the support level while the Directional Movement Index reading was below 20. So, you could have been pretty sure that there was a high probability that the ProShares Ultra S&P 500 (SSO), which is a leveraged s&p 500 ETF, would have continued to remain within support and resistance level.

So, if you place a buy order when the SSO price penetrated the high of this inside bar, you could easily capture the bullish move towards the resistance level. In this instance, when the SSO price approached the resistance level, the Directional Movement Index reading was rising, but still remained below 20. Therefore, you could have simply closed out the long position and exited the trade with a bulk of the profits. Then again, if the Directional Movement Index reading climbed above 20, you could wait for a potential breakout instead!

Conclusion

A leveraged ETF trading strategy that uses the Directional Movement Index can prove to be a great way to make some quick profits, especially on short time frames like the 5 minute chart.

Since leveraged ETFs have built-in leverage, institutional traders often use these instruments to day trade large funds that cannot utilize leverage due to regulatory reasons. This attracts a lot of liquidity and increases the volatility level of certain leveraged ETFs. This offers some great day trading opportunities for retail traders who solely depend on technical trading strategies to capture the short-term movements in the market.

If you are happy to handle large price swings and live to trade volatile instruments, leveraged ETFs can offer a lot of opportunities for short-term trading. By combining the tips regarding Directional Movement Index with some common sense, you can successfully trade leveraged ETFs and make decent profits.

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