Trend Lines Definition

Trend lines are one of the oldest technical indicators. Trend lines are used to identify and confirm existing price trends. They can be drawn on any time frame and can be used on any price chart. The key to using trend lines effectively is the methodology used to draw them on the price chart. Simply put, a trend line is a straight line that connects two or more swing points. A positive sloping line is defined as an uptrend. A negative sloping line is defined as a downtrend.

Positive Trend Line Charting Example

A positive uptrend is when there are higher highs and higher lows on the price chart. If the price is contained by this upward sloping line, the trend is assumed to be intact. This means that there is more demand than supply as the price heads higher. Many new traders make the mistake of assuming that a break of a trend line is going to lead to a steep sell off. While this is potentially true, traders will have to assess the volume and price action on the break of the trend line. Often times the price will have a false break of the trend line only to continue higher. One method for trading positive trend lines is to buy each successful test of the trend line at support.

Uptrend Line

Downtrend Line Charting Example

A negative downtrend is when there are lower highs and lower lows on the price chart. If the price is contained by this downward sloping line, the trend is assumed to be intact. This means that there is more supply than demand as the price heads lower. Traders should look to short each failed test of the downtrend line.

Down Trend Line

Slope of Trend Line

The slope of the trend line is a key component of analyzing the strength of the primary trend. Newbie traders will often look at a steep incline and use the first break of the line to sell short the security. The steeper the slope of the line, the less reliable is the signal generated from the break of that line. When going counter to the primary trend, you will want to wait for both the trend line and the previous swing point to be broken. Remember, that a trend line break does not equal a new trend, it could just mean the slope of the trend is slowing up.

Slope

How to Draw Trend Lines

A valid trend line is comprised of two or more points on a price chart connected by a straight line. The origination point of the trend line is not necessarily the high or low point of the price move. A proper trend line starts from when the actual move begins. The two points on the trend line should be between two pivots. These swing points should have enough price movement to construct a trend line capable of containing the trend. The last component of a trend line is the third point, which is contained by the trend line constructed by the first two points. Trend lines are like every other indicator in that it may not work as intended for every security. So, if you find that the price continually breaks the trend line, do not force it on the chart. Use some other indicator to gauge the direction and trend of the security.

Elliott Wave Theory

Now that you have a basic understanding of trend lines, let’s take a look at things from a different angle.

Decades ago an accountant named Ralph Nelson Elliott discovered a pattern in the chaotic price moves. He found out that when the price is trending, it follows specific waves. According to the Elliott Wave theory, the price completes five impulsive waves when trending, followed by three corrective moves. This is why he named the pattern “The 5-3 Rule”.

Imagine we have a bullish trend. This means the price will have five specific waves on the way up. Three of these waves are in the direction of the primary trend, while the other two waves are corrections.

The three trending waves are called impulses and the other two waves are corrections. So, we have a total of five moves on the way up. When the price interrupts the general trend, we are likely to see a bigger corrective move.

Although this might sound a bit confusing, I assure you that it is simpler than it sounds. For this reason, I have prepared a simple sketch of the Elliott Wave theory.

Elliott Wave Theory

This is an easy-to understand sketch showing you the 5-3 Elliott Wave Principle. It is not that hard to understand after all, right?

Notice that the sketch is separated in two parts – the general trend and the correction. The green arrows indicate the impulse moves and the red moves indicate the corrective moves.

Since you are less frightened of the Elliott Wave principle and its meaning to trend building, I will now show you the 5-3 Elliott Wave trend line analysis formula applied to a real chart. Have a look at the image below.

5 Waves of Elliott Wave Pattern

This is the 1-minute chart of Twitter from Feb 18, 2016. The chart shows you an example of the Elliott Wave theory.

We start with the trending move on the chart, which is marked with a blue bullish trend line. The five numbers on the chart indicate the five waves of the trending move:

Wave 1: This is an impulse move in the direction of the trend.

Wave 2: A small corrective move, which indicates that the bears are present.

Wave 3: This is the move traders love the most. Usually, with the bounce from the trend after move 2 comes the confirmation of the wave pattern at which point traders hop in the market.

Wave 4: Another corrective move, which takes relatively more time than the previous correction.

Wave 5: A bullish explosion, which indicates the climax of the bullish trend.

Move A: This is a move which is contrary to the trend. Notice that this move breaks the bullish trend.

Move B: This move might confuse you. The reason for this is that technically it is a correction of the correction.

Move C: This is the last move of the Elliott Wave pattern. It is opposite to the general trend and it follows the direction of the correction. In our case, this move is relatively small. However, it might get bigger in many other cases.

Notice that after the end of the 5-3 waves, we observe another strong price increase in the direction of the primary trend.

The Elliott Wave theory is a crucial part of technical price action. It gives a more detailed view of the trend lines and the expected corrections.

Fibonacci Levels in Elliott Waves

Yes, this is absolutely correct. Where do we think we are going without the good ole Fibonacci ratios?

Fibonacci levels are a crucial part of Elliott Wave theory. The reason for this is that Ralph Elliott discovered that the size of each wave responds to a specific set of psychological levels. For this reason, you should always have the Fibonacci retracement levels at hand when you create a trend line. The table below will show you the expected size of each price wave according to the Elliott Wave trend line system.

Let me now show you how to work with this table. Let’s take for example wave 3, which is considered the best wave to trade. This wave is expected to reach 261.8%, 161.8%, or 61.8% of wave 2.

Nevertheless, I would like to advise you that the market will always do what it wants to do.

Therefore, keep these ratios in mind for entry and exit targets, but do not expect the market to do what you want.

Trading With Trend Lines

We went through many informative details about the trend lines in stock trading. However, the raw information is nothing without one or two practical examples. I will now show you how to trade trend lines and impulse waves.

In order to attempt trading wave 3, we will need to observe wave 2 retracing 38.2%, 50.0%, or 61.80% of wave 1. This way we will confirm the Elliott Wave pattern and set a price target for wave 3 of a minimum price move equal to 61.8% of wave 2.

If this target is reached, we will adjust our stop loss to a tight level, in order to close the trade in case of a minimum outcome. At the same time, we will still be in the game in case of a 161.8% or 261.8% price move. If the price then completes 161.8%, we will adjust our stop again. This way we can set our target on the eventual 261.8% level and we will be protected in case of a contrary move. If the price completes 261.8%, we will consider the trade 100% successful and close the trade. We will execute the same strategy for wave 5.

Let me now show you the way this strategy works.

Impulsive Wave Extensions

Above you see the 2-minute chart of Oracle from Feb 1, 2016. The image illustrates the 5 waves of the Elliott Wave impulse. The blue lines respond to specific Fibonacci levels and the red lines indicate our stop loss orders. The image shows two long trades on impulse wave 3 and impulse wave 5.

After the price completes the first impulse, the wave 2 decrease retraces 61.8% of wave 1. For this reason, we go long Oracle with the idea of riding wave 3. We put a stop loss order right below the lower wick of the opening candle as shown on the image (Stop 1).

With the next two candles, Oracle’s stock price starts increasing, leading to wave 3. One period later, wave 3 reaches 61.8% of wave 2. This is the first target of our long trade. For this reason, we adjust our stop tighter – as shown on the image.

The price continues with a further increase and twenty periods later the price reaches the 161.8% extension of wave 2. This is the second target of this trade. Therefore, we adjust the stop loss upwards to lock in additional profits. However, this is the last increase of the price. The next two candles are bearish and Oracle hits our stop loss.

In this trade we manage to catch a price increase of $0.28 (28 cents). This equals a profit of 0.77% for one hour of work. Wave 3 is completed and we managed to hit two targets in our trade. However, the third target was not completed and our adjusted stop loss closed our trade.

The decrease, which hits our stop loss, is actually the beginning of wave 4. This is a corrective wave. Seven periods after wave 4 begins, the price reaches 50.0% of the size of wave 3. A bullish bounce occurs, which indicates that the wave might be completed.

At the same time, the bottom rests on the same line, which connects the first and second swing lows. Now we have a clearly established trend line. This means that wave 5 might be on its way.

For this reason, we go long attempting to catch the eventual increase during wave 5. We put a stop loss order right below the bottom at the beginning of the wave, as shown on the image.

Only two periods later the price completes 61.8% of wave 4. Therefore, we adjust our stop loss a bit below this level. We now have the first target of our trade completed. Ten periods later, the price reaches 100.0% of wave 4, which completes the second target of our trade. Again, we adjust the stop loss below this level in order to lock in guaranteed profits. The price continues its increase and we have the opportunity to strike for the third potential target of wave 5. Seven periods later, Oracle’s price reached 161.8% extension level of the previous wave 4. This way, we complete the third target of the trade. We adjust the stop loss again to a level below the target. One period later the price hits our stop and we close our trade.

This time we catch a $0.37 price increase. This equals a 1.02% profit, which we manage to generate for a bit more than 30 minutes.

These two trades generate a total profit equal of 1.79% in one hour and forty minutes.

No matter the types of trend lines you trade, bearish or bullish, the Elliott Wave principles can always be applied. Remember, the Elliott Wave system is an integral part of technical analysis and trend lines.

Conclusion

• Trend lines are one of the oldest and most important on-chart indicators.
• Trends are used to measure price swings.
• Uptrend lines are created when the price prints higher tops and higher bottoms.
• Downtrend lines are created when the price prints lower tops and lower bottoms.
• A break in the trend does not mean a creation of a new trend. Sometimes it means that the slope of the trend is flattening.
• We draw trend lines with connecting two or more tops or bottoms on the chart
• When the trend is bullish, we connect the bottoms of the trend.
• When the trend is bearish, we connect the tops of the trend.
• The Elliott Wave theory is a higher form of understanding trend lines.
• The Elliott Wave principle suggests that trends consist of 5 impulse waves and 3 corrective waves.
• Fibonacci Ratios are essential for measuring the size of every wave in the Elliott Wave theory.
• The best waves to trade in the Elliott Wave theory are wave 3 and wave 5.

The post How to Use Trendlines with the Elliott Wave Pattern appeared first on - Tradingsim.

Technical analysis boils down to predicting the future directional movement by studying past market behavior and you would not likely find a better way to assess the market than moving averages.

Today, we are going to take a look at how you can use moving averages to analyze any price chart, different types of moving averages, how to calculate them, and of course, how they measure up to each other in real trading environments.

While there is more than a handful of different types of moving averages, you only need to learn about a few key moving averages in order to successfully use them in live trading. Hence, we will keep our discussion limited to the most useful moving averages, including the simple moving average (SMA), the weighted moving average (WMA), and our favorite – the exponential moving average (EMA).

What is the Exponential Moving Average?

The exponential moving average (EMA) is a variant of moving averages that looks and acts like any other moving average. If you look at a chart with a simple moving average (SMA) and an exponential moving average, you won’t be able to differentiate at first glance.

However, under the hood, there are key differences regarding how the SMA and EMA are calculated.

Let’s say you are trading the daily chart and looking at last month’s price action. Would you agree that analyzing last week’s price action would offer a better understanding of how the market is behaving today, and today’s price action would likely dictate tomorrow’s price action?

Since recent price data plays a more relevant compared to older price data in shaping the market, it is common sense that you should give more weight to recent data.

The exponential moving average (EMA) applies this very notion that traders should pay more attention to the recent price action compared to the old ones. Although most modern charting packages automatically calculates and plots the various types of moving averages on a price chart, it is always  a good idea that you know how they are calculated as it helps to increase your understanding regarding why moving averages behave differently.

How to Calculate Exponential Moving Average?

Basically, you need to go through three steps to calculate the exponential moving average for trading any instrument.

First, we need to figure out the simple moving average (SMA). If we want to calculate the SMA of the last 10 days, we simply sum up the values of the last 10 closing prices and divide it by 10 to get the SMA.

Once we have the SMA, next we need to figure out the weighting multiplier for the number of periods we want to calculate for the EMA.

The weighting multiplier is calculated with the following formula:

EMA(current) = ( (Price(current) – EMA(prev) ) x Multiplier) + EMA(prev)

You should always remember that the number of periods will have a profound effect on the weighting multiplier as it places greater importance to the most recent price action.

As we are using 10 days in this exponential moving average example, the weighting multiplier would be calculated like this:

(2 / (Time periods + 1) ) = (2 / (10 + 1) ) = 0.1818 (18.18%)

Finally, once you have calculated the SMA and  weighting multiplier values, you can easily calculate the EMA with the following calculation:

(Closing price-EMA(previous day)) x multiplier + EMA(previous day)

Trading with the Exponential Moving Average

While you can use the exponential moving average many ways, professional traders stick to keeping things simple. There are basically two ways you can use the exponential moving averages in trading: (1) using two different period exponential moving average cross to generate buy or sell signals (2) or a single exponential moving average as a dynamic support/resistance zone.

One of the easiest ways of trading with the exponential moving average would be using two different periods on a price chart and wait for the faster period to cross above or below the slower period.

If you see the faster period EMA crossing above the slower period EMA, from a technical point of view, it indicates bullish momentum in the market. On the other hand, if you see the faster period EMA crossing below the slower period EMA, it would indicate bearish momentum in the market.

In addition to using EMA crosses, we can also use the exponential moving average as a dynamic pivot zone. During an uptrend, major EMA periods like the 50 or 200 period EMAs acts as support and resistance zones.

Generating a Buy Signal while Trading with the Exponential Moving Average

Figure 1: 5-Minute Chart of Ford Motor Company (NYSE:F) – October 8, 2015

In Figure 1, we have applied a green colored 13 period EMA and a red colored 21 period EMA on the 5-minute chart of the Ford Motor Company (NYSE:F).

As you can see, in the far left, when the green line moved above the red line, the price soon gained bullish momentum and started to move up. If you took this trade on October 8^th, you would have easily entered a long order around $14.60 per share and exited the trade near $15.10, with a 50 cent profit on each share you traded.

Generating a Sell Signal while Trading with the Exponential Moving Average

Figure 2: 5-Minute Chart of Apple Inc. (NASDAQ:AAPL) – October 8, 2015

In Figure 2, we have once again applied the 13 and 21 period exponential moving averages on a 5-minute price chart, but this time on Apple Inc (NASDAQ:AAPL) to show that this strategy is instrument independent.

As you can see on the second cross on the chart, when the 13 period green EMA crossed below the 21 period red EMA, the price immediately started to gain bearish momentum.

Although the volatility increased significantly, and even if you entered the market after the bar closed below the downward EMA cross, you would still be able to short AAPL at $109.00 per share and exit near $108.20, making a quick $0.80 profit per share in the process.

Exponential Moving Average Example of Dynamic Support and Resistance

In both Figure 1 and Figure 2, you can see that the price often pulled back towards the 13 and 21 period EMAs and then consolidate.

Figure 3: Price Consolidating Around the 10-Period EMA of Apple Inc 5-Minute Chart, October 9, 2015

In Figure 3, you can see that price can find both support and resistance around a major EMA level as well.

Since the EMAs are always moving up or down depending on the price action, these levels act as dynamic pivot zones that you can use to place long or short orders. However, we strongly recommend that you use price action triggers to place the order instead of blindly placing limit buy or sell orders around these lines.

As you can assume by now, both the 13 and 21 are Fibonacci numbers and these two periods are very popular among day traders. Since we utilized 5-minute charts to demonstrate how you can use exponential moving average on real life trades, we used faster period EMAs. If you want to trade the daily or weekly time frames, the 50, 100, and 200 period EMAs would be more suitable for such endeavors.

Why Professional Traders Prefer Using Exponential Moving Average?

When it comes to live trading, professional traders and quantitative analysts tend to favor the exponential moving average (EMA) compared to the other types of moving averages, such as the simple moving average (SMA) and the weighted moving average (WMA).

Compared to using simple moving averages (SMA), the weighted moving average (WMA) offers huge benefits as you can consistently put more importance on the recent price action with the WMA.

However, most beginner traders get confused when it comes to differentiating the exponential moving average (EMA) and the weighted moving average (WMA), because the EMA also uses a weighted formula to calculate the values.

But, there are clear distinctions between the EMA and WMA.

When calculating the weighted moving average, you have to use a consistent weight or multiplier in the formula. For example, the WMA price may decrease by a value of 5.0 for every preceding price bar in the chart to give more weight to the most recent price bar.

Figure 4: The EMA Reacts Faster to Chagning Price Action Compared to the SMA and WMA

By contrast, when calculating the exponential moving average (EMA), the weight or multiplier would not be a consistent one, but it would put more importance to the recent price in an exponential manner. That’s why, the weighting multiplier increases or decreases based on the number of periods or price points.

Therefore, the exponential moving average reacts much faster to the price dynamics and offers a more accurate perception regarding the market compared to the simple and consistently weighted moving averages.

Conclusion

Exponential moving average can be a very powerful tool in the arsenal of a savvy day trader. However, you should remember that price does not react around EMA pivot zones because of any underlying market structures - rather self-fulfilling prophecies.

You see, large hedge fund analysts and other institutional traders often use the major moving average periods to decide if a financial instrument is trending up or down, or just staying within a range. Hence, when a major EMA cross happens or the price approaches these EMAs, where there a lot of traders watching these price levels, they tend to place large quantities of orders around these levels. As a result, when price reaches near these EMAs, the orders get filled and market volatility goes up. Depending on the buy or sell order dynamics around these pivot zones, the price either resumes the trend or changes the prevailing trend altogether.

That’s why, you should always keep an eye on where the major EMA lines are in a price chart regardless if you are using technical analysis or solely depending on fundamental analysis in your trading system.

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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.

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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.

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What is a Displaced Moving Average?

As you have probably noticed, the name “displaced moving average” pretty much contains the answer to this question. The displaced moving average is a regular simple moving average, which is displaced by a certain amount of periods. In other words, displacing a simple moving average means to shift the SMA to the left or to the right. Easy!

How to use the Displaced Moving Average?

Displacing a moving average is a common practice used by traders in order to match the moving average with the trend line in a better way. We all have experienced situations, where the moving average walks the trend line (as a support or resistance), but there are some mismatches and we see that there are slight inaccuracies between the trend and the moving average in the moment of testing the level. Therefore, traders easily “relocate” the moving average forward and backwards by displacing it with a specific amount of periods in order to slide it exactly on the trend line.

It is very important to emphasize that if the moving average is displaced with a negative value, it is displaced backwards (to the left) and it is considered a lagging indicator, while if the moving average is displaced with a positive value, it is displaced forward and it has the functions of a leading indicator. For this reason, the first is used to confirm emerging events on the chart, while the second is more likely to be used for shorter term strategies.

Below you will find an example of the difference between three moving averages.

Three Moving Averages

This is a screenshot of the DAX chart on a H4 time frame. The red line is a standard 50 periods simple moving average. The blue line is a 50 period -5 displaced moving average and the magenta line is a 50 period +5 displaced moving average. As you see, the three lines are moving averages with the same periods. The difference, though, is the displacement factor of the blue and the magenta moving averages. The blue moving average is displaced with -5 periods and it is shifted to the left in comparison to the standard 50 periods moving average (red), while the magenta moving average is displaced with +5 periods and therefore switched to the right in comparison to the red moving average. In this case, the blue displaced moving average (50, -5) looks like a better fit to our trend, because it is a better fit to the already emerged upper trend. Although the price has created a strong bullish movement, an eventual correction would be likely to test the displaced moving average (50, -5) as a support. Yes, it is that simple! A displace moving average is a modification of a standard moving average to better fit a trend line.

How do you recognize which Displaced Moving Average you need?

The answer to this question is quite simple – trial and error! You try; it does not work, so you adjust until it works! Below you see an example, where we have a 20 period Moving Average displaced by +3 periods.

As you see, there are some bottoms here, which conform to the displaced moving average level and use it as a support. On the other hand, there are a few other bottoms, where the price has closed below the displaced moving average. This means, that the moving average might be better to be displaced in the opposite direction in order to give us a better support outlook for situating our stop loss order. Let’s shift the moving average forward! We change our displaced moving average (20, +3) to a displaced moving average (20, -3):

Voila!

As you see, the bottoms of this uptrend are much better situated on the displaced moving average (20, -3) in comparison to the previous example, where we had few bottoms beyond the scope of the moving average. In some cases, the displaced moving average provides higher level of accuracy for determining support and resistance levels. Therefore, some traders often use this type of moving average in addition to their trading strategy.

How can I adapt the Displaced Moving Average indicator to my strategy?

We are going to go through three suggestions of how the DMAs could be combined with other trading indicators.

1. Combining a Simple Moving Average (SMA), with the same period Displaced Moving Average (DMA) + Momentum Indicator

Below you will find a screenshot of the EUR/NZD currency pair on a M30 chart.

Combining a Simple Moving Average (SMA), with the same period Displaced Moving Average (DMA) + Momentum Indicator

We have supported our M30 EUR/NZD Chart by two Moving Averages – SMA 50 (red) and DMA 50, -10 (magenta). In addition to our strategy, you will see below a momentum indicator. The situation on the chart is an example of an opportunity for a short position, which could have led to a profit of about 500 bearish pips in 24 hours. How could we do that? There it is right there!

- First, we start with a strong bearish divergence between the momentum indicator and the previous bullish movement of the EUR/NZD currency pair (marked with the two yellow corridors on the image)

- Second, the momentum indicator interrupts its 100-level line in a bearish direction, which gives us a second bearish signal, speaking of a clear bearish potential.

Not enough? This is where the DMA comes in use.

- Third, the magenta DMA 50, -10 breaks the SMA 50 in bearish divergence, confirming the authenticity of the upcoming bearish activity.

In this case, our displaced moving average formula helped us identify a potential reversal, where the consequences are the following: a strong bearish drop of the EUR/NZD with about 500 pips for 24 hours. The two signals of the momentum indicator inferred about an upcoming bearish activity, while the role of the DMA and the SMA concluded the bearish idea and gave the last bearish signal needed for going short.

At the same time, the momentum indicator is the tool which will give us a proper signal for getting out of the market. If the momentum indicator interrupts its 100-level line in the opposite direction of your position (in our case in a bullish direction), feel free to close your position and to collect whatever you have managed to get out of the trade.

        2.  Combining a positive and a negative Displaced Moving Average (DMA) with the same period Simple Moving Average (SMA) + parabolic SAR

Below you will see a screenshot of a USD/CAD H4 chart.

Combining a positive and a negative Displaced Moving Average (DMA) with the same period Simple Moving Average (SMA) + parabolic SAR

Here, we are using three moving averages – two DMAs, 30, -10 (magenta) and 30, +10 (blue), and SMA 30. As you see, we have created a displaced moving average channel, where in the middle we have a control line of a regular SMA 30. The green dots are our Parabolic SAR. So, when do we go into the market?

- First, we wait for a move of the market, followed by a distanced Parabolic SAR point. Look at the chart above and find “I. This Point”. As you see, after the currency pair drops, we get the first clearly distanced dot, which “II. Responds to this candle”.

- Second, after we find our point and respective candle, we check up our DMAs and SMA. We are looking for a distance between them, which will support the bearish movement we are looking for. In “III.” we have the situation we are looking for. The moving averages have just separated from each other, which is our last signal for our short position.

- Third, we go short and we start following the Parabolic SAR indications and the distance between the Moving Averages for an eventual “Get out of there!” signal.

The first more remarkable correction of the bearish drop is noted by 1 Parabolic SAR point – not a big deal. Then we get 9 more bearish points – sweet! Then we get 10, a bigger correction marked with 10 bullish Parabolic SAR points – danger. Nevertheless, we cannot just get out of the market based on a bunch of points. Therefore, we also follow our DMAs and SMA. As you see, in the moment of the dangerous correction, our moving averages recorded a strong hesitation in their bearish intentions, which is the more dangerous event for our position. If you are in the category of the more risky traders and you still want to stay with your position, the day after you will find out that the Moving Averages got closer to each other and even crossed. This should be enough for you to collect whatever you have made out of this short position – between 300 and 350 pips depending on how tough you are!

        3.  Displaced Moving Average (DMA) and Simple Moving Average (SMA) + Stochastic Oscillator and Relative Strength Index (RSI)

Below you will see an H4 chart of the AUD/USD Forex pair.

Displaced Moving Average (DMA) and Simple Moving Average (SMA) + Stochastic Oscillator and Relative Strength Index (RSI)

In the current example, the DMA (magenta) is modified to fit trend number 3. For each trend should act different DMA, shifted to contain the trend in the best possible way.

In this strategy, we use a displaced moving average (DMA), which should be modified with each swing of the trend, and a bigger period simple moving average, in order to get crossovers of the two moving averages. In addition, we have RSI and stochastic oscillators.

This is how it works:

- First, our initial signal should be from the RSI or the stochastic – to enter the overbought or the oversold market area.

- Second, we get one of these indicators in the overbought or the oversold market area, we wait for the other indicator to do the same and to confirm the signal.

- Third, after we get the second overbought/oversold signal we wait for a cross between the DMA and the SMA. The place of the cross is where we should open our position.

- Fourth, when we open our position, we modify our DMA in order to contain the trend better (shown in 3.)

- Fifth, we close our position whenever the RSI gets into the opposite market area and starts getting out of there, or whenever the two moving averages interact with each other again.

Let’s now go through the particular cases demonstrated in the image above:

Trend 1: We get an oversold signal from the RSI. A second oversold signal comes from the Stochastic Oscillator. Moving averages interact with each other and we go long! Then we modify our DMA to contain the trend better. We follow the trend with our DMA until we see that the RSI goes for a blink in the overbought area and starts moving in the opposite direction. This is where we go out and we collect about 200 bullish pips.

Trend 2: As we said, the RSI gave us an overbought signal. The same happens with the stochastic oscillator. Before we say our names, the DMA and the SMA cross and we go short. We modify the DMA to fit the trend if needed and we start following the sweet bearish tendency. We close our short position in the moment when the RSI goes into the oversold market area. This happens simultaneously with the stochastic oscillator. The result – 130 bearish pips.

Trend 3: The RSI and the stochastic oscillator went in the area of the oversold market. We wait for the DMA and the SMA to interact and to go long. This does not take a lot of time. We go long and we follow our trend with the shifted DMA. Unfortunately, we are forced to get out of the market earlier, because the RSI gets into the overbought area pretty fast. We still manage to realize a decent profit of 160 bullish pips, but we have skipped an opportunity for twice more. That doesn’t matter, because we are pretty happy with our total of approximately 490 pips from three market swings!

It is very important to emphasize that although it does not happen in these three examples, positions should be closed in case of a stronger interruption of the displaced moving average!

Note that each of these strategies could be supported with additional trading tools in order to get clearer signals for going long or short. Therefore, it is always a plus to double check the signal you get with an additional trading instrument, or simple chart patterns and candle patterns.  As we all know, there are a lot of them out there!

For example, see in our first strategy by the EUR/NZD, that the last movement of the price ends with a falling wedge formation. We all know its strong bullish potential. Why not take this into consideration?

Look at our second strategy which is demonstrated on the USD/CAD Forex pair. The last few swings of the price draw a pure inverted head and shoulders formation, which support the reversal implied by the Parabolic SAR and the displaced moving average channel. After all, we should not miss the opportunity to be more secure in our trading position!

In Summary

• The displaced moving average is a great way to adjust a regular simple moving average to fit a trend line in a better way.
• It has the same function as a regular simple moving average – to determine support and resistance.
• If the moving average is displaced with a negative value, it is shifted to the left and it is lagging. If the moving average is displaced with a positive value, it is shifted to the right and it is leading.
• Trial and error is the way to discover the right displaced moving average for you.
• The displaced moving average can be combined with other trading instruments in order to clarify signals from the market. Some of these are:
• Simple Moving Average
• Momentum Indicator
• Parabolic SAR
• Stochastic Oscillator
• Relative Strength Index (RSI)
• Chart Patterns
• Candle Patterns
• Retracement Levels
• Effective trading strategies including the displaced moving average:
• X Period SMA, X Period DMA, Momentum Indicator
• X Period DMA -d, X Period SMA, X Period DMA +d, Parabolic SAR
• X Period SMA, Y Period DMA, RSI, Stochastic Oscillator

The post 3 Ways to Use a Displaced Moving Average (DMA) in Addition to Your Trading Strategy appeared first on - Tradingsim.

Random Walk Index Definition

The random walk index (RWI) is a technical indicator that attempts to determine if a stock's price movement is random or nature or a result of a statistically significant trend.  The random walk index attempts to determine when the market is in a strong uptrend or downtrend by measuring price ranges over N and how it differs from what would be expected by a random walk (randomly going up or down).  The greater the range suggests a stronger trend.  The RWI states that the shortest distance between two points is a straight line and the further prices stray from a straight line, implies the market is choppy and random in nature.

Random Walk Index Formula

The random walk index determines if a security is in an uptrend or downtrend.    For each period the RWI is computed by calculating the maximum of the following values for high periods:

(HI - LO.n) / (ATR.1(n) * SQRT(n))

For each period the RWI  is computed by calculating the maximum of the following values for low periods:

(HI.n - LO) / (ATR.1(n) * SQRT(n))

Trading with the Random Walk Index

Michael Poulos the creator of the RWI, discovered during his research that it was best optimized for 2 to 7 periods for short-term trading and 8 to 64 periods for long-term trading.  Readings of the long-term RWI of highs that exceed 1 provides a good indication of a sustainable uptrend.  Conversely, a long-term RWI of lows above 1 provide a good indication of a sustainable downtrend.  Poulous realized that by combining the short-term RWI with the long-term RWI in a trading system, it could provide accurate buy and sell points.  Below are some rules developed by Poulos for trading stocks and futures with his RWI:

• Enter a long (or close short) when the long-term RWI of the highs is greater than 1 and the short-term RWI of lows peaks above 1
• Enter short (or close long) when the long-term RWI of the lows is greater than 1 and the short-term RWI of highs peaks above 1

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Price Oscillator Definition

The price oscillator displays the difference of two moving averages in either points or in percentages.  This technical indicator is very similar to the MACD, but there are two main differences.  (1) The trader can define any two input parameters for the periods of the moving averages, while the MACD is always 12 and 26.  (2) The price oscillator can be expressed in terms of percentages, so buy and sell signals can be generated as the price oscillator shifts from positive and negative territories.

Price Oscillator Formula

To plot the price oscillator in terms of points use the below formula:

Shorter Moving Average - Longer Moving Average

To plot the price oscillator in terms of percentages use the below formula:

(Shorter Moving Average - Longer Moving Average)

-------------------------------------------------------------------     *  100

Longer Moving Average

Trading Methods

There are numerous trading methods for the price oscillator.  Since the indicator is a trend following system, majority of traders follow a very simple rule of buying when the shorter average crosses above the longer average and conversely when the shorter average crosses below the longer average a sell signal is triggered.  Another method is to fade the signals and go in the opposite direction.  This generally works better in choppy markets, as the moving averages are not permitted to trend due to a range bound market.

Positives

As stated above, the price oscillator is a trend following indicator, so naturally the indicator works best in trending markets.  Remember, that crosses in the moving averages will generate buy and sell signals, so in trending markets, there are few signals triggered, which allows a trader to maximize their gains, by riding the stock for big profits.

Negatives

Traders can find themselves in serious trouble with the price oscillator when the market is choppy.  For example, if a stock is trading within a range of $20 - $25 dollars, as the stock approaches $25, the shorter moving average will often close above the longer average due to the upward move in price.  To the detriment of the trader, the range will provide resistance at the $25 level and the stock will once again head lower.  Depending on the traders stop loss strategy, at a minimum this situation will cause a number of false signals and losing trades.

Price Oscillator Charting Example

Price Oscillator

Price Oscillator Divergence

Like other indicators, the price oscillator also exhibits divergences on both the bullish and bearish side.

Bullish Price Oscillator Divergence

The bullish price oscillator divergence occurs when the price on the chart is decreasing, while the indicator line is increasing. This is likely to cause a rapid reversal on the chart followed by a bullish extension.

Bearish Price Oscillator Divergence

As you probably guess the bearish price oscillator divergence is opposite to the bullish one. It happens when the price action is increasing, while the PO line is decreasing. This event is likely to lead to a rapid reversal on the chart, followed by a bearish extension.

This is what the price oscillator divergence looks like on the chart:

Price Oscillator

Above you see a classical example of a bullish divergence between the PO indicator and the price action. See that the price is following a strict bearish trend. At the same time, the price oscillator line is making higher bottoms. This confirms the presence of the bullish divergence on the chart. As you see, the price then reverses and enters a bullish trend, which is even sharper.

The bearish divergence works the same way, but in the opposite direction.

3 Strategies Using the Price Oscillator Technical Indicator

Now that you are pretty familiar with the structure of the PO indicator, we will discuss three trading strategies.

#1 - Price Oscillator + Candlestick Patterns

One method for using the price oscillator is by combining it with candlestick patterns. This means that we will take into consideration only crosses of the zero line supported by a candle pattern in the same direction.

Imagine a stock is trending downwards. Suddenly, the PO indicator creates a bullish crossover at the zero line. At the same time, the bearish price action creates a reversal candle pattern. If the pattern is confirmed, you will have a strong bullish signal from both indicators.

You should trade this setup in the bullish direction, placing a stop at the other side of the pattern.

Then you should trade until you get an opposite signal from the price oscillator, or until the price action tells you otherwise.

It works the same way in bearish direction, or when trading price oscillator divergence.

Now let’s approach a real trading example with the price oscillator and a candlestick pattern:

Price Oscillator and Candlesticks

Above you see the 5-minute chart of General Electric from September 6^th, 2016. The image illustrates a bearish price oscillator trade supported by a bearish candlestick pattern.

The image starts with the PO indicator crawling around the zero level without making a move. Suddenly, on September 6^th, a bearish engulfing pattern develops.

At the same time, the price oscillator begins to trend below the zero level.

This gives us two matching bearish signals and we open a short trade.

We place a stop loss order above the highest point of the pattern. This way our trade is protected from any unexpected movement.

As you see, the price action enters a bearish trend afterwards. The trend is so consistent, that we can measure it with a bearish trend line.

According to our strategy we need to exit the trade the moment the price action breaks the trend. This is shown in the red circle and the sign “Close 1”. We get a price action signal in a bullish direction, which forces us to close the deal.

The other exit opportunity comes when the price oscillator breaks the zero level upwards. This creates an opposite signal on the chart, shown in the other red circle with the sign “Close 2”. Of course, the first closing alternative is the better one since the price is lower.

#2 - Price Oscillator + 50-Period TEMA

The triple exponential moving average (TEMA) is another tool you can combine with the PO indicator.

The TEMA is a moving average indicator; however, the moving averages are exponential.

In this manner, the TEMA shows the same perspective on the chart, but looked through the angle of an EMA. For this reason, matching signals between the two tools create strong signals on the chart.

In order to provide more accurate signals, the TEMA needs to be slowed down a bit, so it can mirror the number of trade signals of the PO. For this reason, we will change the value of the triple EMA line to 50-periods.

We will enter trades only when matching signals occur on the chart. At the same time, we will stay in our trades until the PO line creates an opposite signal.

Although we will close our trades only based on PO signals, we will use a stop loss order. This way we will protect our trades against high volatility moves against our position. The stop loss order should be placed beyond a top/bottom created prior to the signals.

Let me now show you how exactly this strategy works.

Price Oscillator and TEMA

Now we are looking at the 5-minute chart of FedEx from Sep 14, 2016. We have the PO tool at the bottom of the chart and a green 50-period TEMA line. The case illustrates the harmony between the TEMA and the PO indicators.

It all starts when the price action creates a bearish breakout through the green TEMA line. This gives us a signal that the price might enter a bearish trend. But we still don’t have a bearish signal from the PO indicator.

The signal develops 17 periods later. The price oscillator line breaks the zero level downwards, giving us a bearish signal.

Now we have a bearish signal from each of these two indicators. Thus, we sell FDX and we place a stop above the most recent top as shown on the image.

See that the price enters a bearish trend afterwards. At the same time, the TEMA line works as a resistance. The FDX price action reaches the area around the TEMA and it then bounces lower. See that a breakthrough the TEMA line appears at one point. Yet, we hold the trade until the PO gives an opposite signal as stated in our strategy.

The price keeps decreasing; however, the PO indicator accounts for higher bottoms (blue lines). This creates a bullish divergence on the chart. You can use this signal to close your trade (Close 1).

If you don’t manage to see the divergence on time, you can hold until the PO crosses the zero line. This happens in the moment indicated with “Close 2”.

#3 - Price Oscillator + Volume Indicator

The last tool we will use with the PO is volume.

The volume indicator is a good way to confirm any signal on the chart. The best thing is that it is pretty easy to understand and use. The rules are simple; if a lot of people are in the market, the price is likely to enter a trend. If not many people are in the market, the price action is not likely to be persuasive. In other words, higher volumes lead to trends while low volumes stay range bound.

What we will do here is to trade only price oscillator signals, which appear during high or increasing volumes. This would mean that the price action is likely to start moving in the direction of the trade signal.

Contrary to this, we will avoid PO signals during low volumes. The reason for this is that lower volumes imply that the PO signal is more likely to be false.

To position your stop loss orders, you need to use some price action techniques. We will place our stops beyond tops and bottoms created prior to the signal.

To exit our trades, we will keep an eye out for decreasing volumes on the chart.

When volumes are decreasing, the trend is likely to slow down too. In this manner, we can observe the volumes effect on price. When you see the volumes getting lower and price hesitating, then the trade needs to be closed. This profit taking approach can be tricky at times.

Let’s now move on to a real trading example with the price oscillator and the volume indicator:

Price Oscillator and Stop Loss

You are now looking at the 5-minute chart of Tootsie Roll Industries from September 9^th, 2016. Our graph now includes the volume Indicator above the price oscillator.

The chart begins with a range, which grows into a decrease. At the same time, the volume indicator is increasing in volume.

Meanwhile, the PO breaks the zero level downwards. These three events on the chart tell us that the price action is probably entering a bearish trend. Thus, we sell the TR security.

Then we place our stop loss order to protect our trade from unexpected events on the chart. The stop is located above the high prior the price decrease as shown on the image.

See that the TR price decreases afterwards. Meanwhile, we get another volume bar which is even bigger than the previous three. This supports the theory that the trend is currently bearish.

Sadly, the next bigger volume bar is lower than the previous one. At the same time, the price action on the chart slows down. The bearish intensity seems to be decreased (blue). Then we get another bigger volume candle, which is even lower. This way we account the decreasing volumes with the TR stock.

This is a very good place to exit the short trade with Tootsie Roll Industries (Close 1). But, the markets are about to close 30 minutes later. If you choose to hold the trade, you can use the “Close 2” option, which is situated in the last period prior the market closing.

I advise you to stick with the “Close 1” alternative here as stated in our strategy. After all, you won’t be that lucky every time to get your exit signal right prior to the market closing.

Which is the Best Price Oscillator Strategy?

My personal preference supports the volume indicator as the best tool to combine with the PO. The reason for this is hidden in the essence of volumes in trading. The better you read the volumes, the less false signals you will get on the chart.

The TEMA could also be a very efficient tool when combined with the price oscillator. However, the TEMA is relatively dynamic, no matter how high you adjust the indicator. Thus, the TEMA could give you a relatively large number of fake entry signals.

Candlestick patterns are also an excellent way to confirm signals on the chart.

Conclusion

1. The Price Oscillator is a technical indicator, which represents the price difference between two custom SMAs.
2. The indicator consists of a single line, which bounces above and below a zero level.
3. The PO formula takes the smaller SMA and subtracts the bigger SMA from it, giving a value.
4. The basic price oscillator signals are:
   1. PO line switches above 0.00 - Long Signal
   2. PO line switches below 0.00 – Short Signal
   3. Bullish PO Divergence – Long Signal
   4. Bearish PO Divergence- Short Signal
5. Three of the strategies to successfully use the Price Oscillator use the following tools:
   1. Candlestick Patterns
   2. Tripe Exponential Moving Average
   3. Volume Indicator
6. The best alternative out of these three options is the Volume Indicator because:
   1. High volumes confirm well the entry signals generated by the price oscillator.
   2. Low volumes hint that the trend is being exhausted.
   3. Volumes are crucial in trading.

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Technical analysis is a means of being secure as a trader in the stock market. It provides the discipline on how to be able to predict movement in prices by studying past market data on price and volume.

Alpha-Beta Trend Channel: This gives a measure of the profit derived from investing riskily on a fund. When positive, it indicates that the profit is higher than the risk taken.
Arms Ease of Movement: This is a tool that tries to measure the ease at which prices of stocks in the market will rise or fall by comparing current prices with volume.
Average True Range: This measures the periodic changes in the prices of securities
Bollinger Bands: This is a technical analysis tool that is used to measure the degree of changes in price of securities when compared with previous prices.

Candlestick Charts: A tool used to understand present prices and predicting future price actions. By the understanding of this, the trader knows when best to buy and sell, thereby making more profits in his transactions.

Chaikin Oscillator: This tool is used to analyze how the flow of money and price action interact by measuring the final price of securities at the end of each day’s trading and comparing it with the high and low prices of securities that were encountered during the day’s trading.

Commodity Channel Index: This is used to know when the prices of securities have risen either very high or very low within a very short period of time. It helps the trader to know when currencies will suffer a pullback. Hence, it helps in effectively managing cyclical trends.

Commodity Selection Index: This is a tool that helps the trader in knowing commodities that are suitable for short term trading. Commodities of this kind are highly volatile and can give quick gains for lesser risks on investments.

Cutler's RSI: This is used to find out conditions where securities have either been overbought or oversold.

Demand Aggregate: This is the total amount of stocks demanded in the market.

Demand Index: This tool is used to predict future prices on securities by combining price and volume. Most times, the volume tends to get to the peak before prices do.

Detrend: This is eliminating the impact of time on a trend by using retrogression and other statistical techniques to make it easier to predict likely cyclical patterns.

Directional Movement Index: This tool is used to know if an instrument is giving a trend or not.

Elliott Wave Theory: This states that the stock market can be well predicted by understanding patterns of waves (that repeat themselves).

Fibonacci Ratios and Retracements: This is used to predict where and when favorable and unfavorable conditions will be encountered. This can be done by dividing the vertical distance of two extreme positions on the stock market chart by Fibonacci ratios. The ratios are commonly used as 23.6%, 38.2%, 50%, 61.8% and 100%.

Gann Square: This method is used to predict future support or resistance levels by counting from the origin. The origin is the price at which the instrument is always low or high..

Haurlan Index: This is an indicator that is used to measure the size of the market.

Head and Shoulder Pattern: This is a description of the pattern a chart can achieve when it rises and falls abruptly. This happens if the chart rises first to a very high position then falls back very rapidly, rising again the second time to a point higher than the first rise and then falling again sharply. Finally, it rises again but this time, not as high as the second one. The resulting chart will look like a head and shoulders by the combination of the first and third rise (the shoulders) and the second rise (the head).

Herrick Payoff Index: This compares the relationship among daily changes in price, volume and open interest to know the amount of money flowing into or out of a futures contract.

Kagi Chart: This is a chart used in determining price movements so that a trader can know when best to buy stocks. It differs from candlestick chart in that it is independent of time.

MACD (Moving Average Convergence/Divergence): This is an Absolute Price Indicator. That is, it shows the relationship between two moving price averages (a fast and a slow Exponential Moving Average) by taking the difference of their prices.

McClellan Oscillator: A tool used for short and intermediate term trading. It measures the rate at which money enters or leaves the market. The results are used to determine overbought and oversold conditions in the stock market.

Momentum: This is the rate of change in price of stocks.

Moving Averages: This is a technical analysis tool that helps the trader know an average value of the price of a security for a defined period of time. It is best suitable for a volatile market.

Norton High/Low Indicator: This tool picks bottoms and highs on long term price charts. In doing this, it combines results obtained from the Demand Index and Stochastic study.

Notis %V: This is used to measure how volatile or inconsistent the market is by dividing the market into two parts: The downward (DVLT) and the upward (UVLT) parts using its two separate indicators.

On Balance Volume: This uses cumulative total volume in the market and price changes to detect momentum.

Parabolic: This is a strategy that uses the reverse method known as “SAR” (Stop –And-Reversal). It states that if stock trading is below the parabolic SAR, one can sell. But buying is rather encouraged if the stock market is above the parabolic SAR.
Point and Figure Charts: This chart provides daily changes in price so that the investor can know the present stock prices as well as become able to use emerging trends to know when to buy or sell securities.

Price Patterns: This is a way of analyzing the stock market to know whether prices of security have risen, fallen or remained stable. A rising price pattern occurs when there are more buyers than sellers. A falling price pattern occurs when there are more sellers than buyers. Finally, a stable price pattern occurs when the number of buyers and sellers are equal.

Random Walk Index: This is a tool that tries to find out the cause of changes in price of securities. It tries to explain if the changes in price are following a trend or if they are just random (without a defined direction).

Rate of Change: This is a momentum oscillator that expresses the change in price of stocks as ratios or percentages by comparing current and previous prices.

Relative Strength Index: This is a tool used to analyze the strength of the market by comparing the closing prices at the end of a trading period. In summary, it states that in a strong market, prices will close higher while in a weak market, prices will close lower.

Renko Chart: This chart disregards the changes in time and volume as it measures price movement.

Stochastic: This is a momentum indicator that compares the closing price of a security to the security’s price range over a certain period of time. When the current price is above the high range, it indicates that there is buying pressure while a selling pressure is indicated when it is near the low range.

Stoller STARC Bands: STARC means Stoller Average Range Channels. It is used to give meaning to the volatility of a market by using the Average Time Range (ATR).
Swing Index: This compares previous prices of a security in a particular period of study with the current prices to know what the actual price of the security might be.

Time Cycles: The knowledge of this helps the investor to be successful in trading. It helps to know how the market is likely going to move.

Trading Index: This is an indicator that explains whether the market is bullish or bearish.

Trix: This means Triple Exponential Average. It is used to show markets that have been overbought or oversold.

Volume Accumulation: This is a tool used to modify results from On Balance Volume Tool. It gives a more accurate and precise value of a day’s volume by expressing only a percentage of it as positive or negative.

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Many of the technical indicators discussed on the Tradingsim blog deal with assessing a particular stock or ETF. However, in this article we will cover the tick index, which is a broad market momentum indicator used to gauge the strength of the underlying securities of the NYSE.

The tick index is important, as it will better position us for when we should enter and exit the markets based on a macro view of price action.

On first glance, the tick index looks a bit chaotic, but as you learn to interpret the readings, the wealth of information it contains will prove very useful when day trading or swing trading.

What is the Tick Index?

The tick index measures the 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 2700 stocks on the NYSE and 2000 of them printed an uptick while 700 printed a downtick, the tick index would read  +1300.

How to Use the Tick Index When Day Trading

If you take a look at the below chart, it will look like a bunch of noise.  However, this notice represents extreme 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 close 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.

I use readings of +1000 and -1000 to scale out of all long and short positions and even think about going in the opposite direction.

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.

Tick Index

#1 - Confirming Moves with NYSE Tick Index Data

Since we have covered the power of the tick index to identify market reversals, I want to now focus on how the tick index can be used to confirm the strength of the market.  To this point, we will identify tick readings of +1000/-1000 to confirm bullish or bearish sentiment respectively.

Have a look at the image below:

Tick Index Example

This is the daily chart of Bank of America (BAC), from the period of October 2015 to March 2016. Below the chart you see the NYSE tick index chart. The red arrows indicate tick index readings of -1000, which correlate to BAC price decreases. At the same time, green arrows indicate readings of +1000, which correlate to BAC price increases.

Let’s start with the first green arrow on the left from Oct 21, 2015. On this day, the tick index registered a reading of +1100. On the same day, BAC increased 1.00%, followed by another 1.00% increase the next day.

The next arrow is red and it indicates a low tick index reading of -1060. On this day, BAC dropped -1.3%.

On the third arrow, the tick index registered a reading of -1145. Meanwhile, Bank of America’s price tanked -2.87%. This decrease is followed by a further price drop of -2.56% the next day. Notice how the price decreases expanded as the tick index dipped below -1100.

The fourth red arrow registers a reading of -1133 on the tick index and BAC sees its price drop -4.83%.

In addition, as you can see on the chart, BAC is in a bearish trend at this point.

If you compare the BAC chart with other stocks during this time period, you will notice a bearish trend for the months of December through February.

Just as it appears the entire world is coming to an end, the tick index registers a solid bullish up day on the fifth arrow.

On this day, the tick index gives a reading of +1214 (fifth arrow), which is relatively high. At the same time, BAC stock price increases 3.59%.

Then after dropping to $11.00 per share, we see another high tick index reading of +1056 on the sixth arrow; meanwhile, BAC’s price increases 4.18%. This is a turning point for BAC, because it looks like the bearish trend is interrupted.

The seventh and last example in the image above is a bullish reading on the tick index.

The index registers a reading of +1238. This high reading was also the day BAC’s price increased 4.36%.

To summarize:

We have seven cases on the BAC stock chart, which are confirmed by the tick index:

Oct 22, 2015: +1.00%, Tick Index Reading +1100

Nov 12, 2015: -1.30%, Tick Index Reading -1060

Dec 17, 2015: -2.87%, Tick Index Reading -1145

Jan 08, 2016: -4.83%, Tick Index Reading -1133

Jan 29, 2016: +3.59%, Tick Index Reading 1214

Feb 12, 2016: +4.18%. Tick Index Reading 1056

Mar 01, 2016: +4.36%, Tick Index Reading 1238

Let’s now take a look at another real-life example.

NYT - Tick Index Example

This is the daily chart of General Motors from October 2015 through March 2016. On the chart you see six green circles and one red circle. These are the exact moments and dates we discussed on Bank of America’s chart.

In the green circles, the price action of General Motors mirrors that of BAC.  Only in one example, highlighted in red, did the price action not correlate between the two securities.

Are you starting to see how individual stocks move in unison with the broad market? If you understand what is going on at the macro level, you will naturally have greater odds of success with your individual trades.

#2 - Divergence Trading with the NYSE Tick Index Symbol

Bullish Divergence

We have a bullish divergence between the tick Index and a security when the NYSE Tick shows higher bottoms and the chart of the equity shows lower bottoms. After a bullish divergence between the ick indicator and the stock chart, the price of the security is likely to exhibit a bullish move. In many cases, the reversal is rapid.

Bearish Divergence

When an equity price closes with higher tops and the tick index has lower tops, this is a confirmed bearish divergence. The bearish divergence between the tick and the stock chart signals a potential downward price move.

Discovering divergence with the NYSE tick index is a leading indicator before the actual event occurs. Thus we can position ourselves in the market prior to the start of a potential price move.

Tick Index Divergence Example

Bullish Divergence - Tick Index

Above is the hourly chart of Twitter from December 2015 through March 2016. Below the chart, we have the NYSE tick index for the same period of time. The image illustrates a bullish divergence between the tick index and Twitter.

Notice that for the period January 19, 2016 through February 11, 2016, Twitter has lower bottoms. For the same time period, the tick index has higher bottoms. This confirms a bullish divergence between the price of Twitter and the tick index.

After the bullish divergence is confirmed, we see that Twitter experiences a rapid short squeeze. This squeeze lasts for 8 days and results in Twitter’s stock increasing a whopping 35.56%!

This type of move is rare, but it illustrates the power the broad market can have on a stock that is oversold relative to the entire market.  Assuming a stock like Twitter is not headed for the woodshed, the price action of the stock will return to equilibrium with the overall market.

Let’s now review a bearish divergence example.

Bearish Divergence - Tick Index

This is the daily chart of the New York Times (NYT) from October 2015 through March 2016. The chart is supported by the NYSE tick index in the bottom of the image over the same time period.

The New York Times stock chart shows higher tops form October 2015 through December 2015.

For the same time period, the NYSE tick index indicates lower tops. This confirms a bearish divergence between the tick indicator and the New York Times price chart.

As a result, in the beginning of December, the NYT price begins to decrease.

Over the next 45 days, the New York Times drops 17%. While this is smaller than the price run up of Twitter, it is still sizeable.

Rules when Trading with the NYSE Tick Indicator

First, never to rely solely on the tick index. Make sure you always confirm your tick signals with an additional trading indicator.

Secondly, the more periods you take into consideration on the tick index, the more reliable the signals. Let’s take the tick divergence as an example.

If one day the tick index registers a high reading, while the price of a security is decreasing, we have a bullish divergence. However, daily discrepancies are likely occurrences and shouldn’t be given too much weight.

Now, imagine if the price of the security is decreasing for a longer period of time and at the same time the tick index is steadily increasing.

In this case, due to the longer periods of divergence, there is a greater likelihood the security will experience a short squeeze at some point.

If you are trading a security based on a tick index signal, make sure you confirm the price behavior with another stock in the market. This way you can validate the security is performing relative to its peers and not experiencing some sort of anomaly.

Conclusion

• The NYSE tick index is used to confirm potential price moves of the broad market.
• The tick index can also be used to confirm divergences in stocks.
• Values of +800 and above or -800 and below are considered strong and reliable.
• Before you start using the tick index to assist your trading system you should remember:
• The tick index is not a standalone indicator.
• The more periods you use as a signal on the tick chart, the more reliable the reading.
• If you want to take a trade based on a signal from the tick index, make sure you check the behavior of other stocks before placing any trades.

The post How to Trade with the Tick Index – 2 Simple Strategies appeared first on - Tradingsim.

Chande Momentum Oscillator Definition

The chande momentum oscillator (CMO) was developed by Tushar Chande and is a technical indicator that attempts to capture the momentum of a security. Chande discussed this and many other indicators in his book "The New Technical Trader". The chande momentum oscillator differs from other technical indicators like the RSI and MACD, because it uses up and down days in both the numerator and denominator. Below is the formula for the chande momentum oscillator:

Chande Momentum Oscillator

Su is the sum of the difference between today's close and yesterday's close. Sd represents the absolute value of the difference between today's close and yesterday's close on down days.

Chande Momentum Oscillator Overbought & Oversold Levels

he CMO is a unique oscillator, but like all other oscillators, it has overbought and oversold levels. Since the indicator is based on previous closing prices, it will oscillate between +100 and -100. Traders use a general rule of thumb that when the chande momentum oscillator is greater than +50 the security is said to be overbought, while a reading below -50 is considered oversold. Traders should not simply buy or sell a security because the indicator crosses these thresholds, this is a sure way to lose money.

Trading with the Chande Momentum Oscillator

Trading with the chande momentum oscillator as a standalone indicator can prove a challenging task. Since the indicator will oscillate between +100 and -100, a break of +50 could mean that it is overbought, but remember the indicator has another 50 points it can run. What many traders do is to apply a moving average to the indicator and will use crosses of the CMO and a simple moving average to generate trade triggers. Another approach is to trade a security when the chande momentum oscillator has reached extreme readings. Extreme readings are an indication that a strong trend is in place, and traders will add to their positions on any minor corrections.

Chande Momentum Oscillator Charting Example

The below chart is courtesy of CMS Forex.

Chande Momentum Oscillator Chart

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Andrew's Pitchfork Definition

The andrew's pitchfork was developed by Dr. Alan Andrews and is a technical indicator comprised of three trend lines. These three trend lines are extended parallel to each other, thus the formation of a pitchfork.

Constructing The Andrew's Pitchfork

The first step in constructing the andrew's pitchfork is selecting a major peak or trough. This major swing point will later be the origin of the median line for the indicator. The next part of the channel is to select the next swing high and swing low pivots after the major swing point. A line is then drawn from the major peak or trough through the middle of the second and third swing points. Lastly a line is extended from both the second and third pivot points parallel to the median line. These three parallel lines give the appearance of a pitchfork. Drawing the andrew's pitchfork is a subjective exercise and most trading platforms will provide the indicator within their suites of tools. This automated way of constructing lines, can provide a more accurate depiction of the indicator.

Trading with the Andrew's Pitchfork

Traders should use the same methods for trading trend lines with the andrew's pitchfork. A big advantage of the andrew's pitchfork over traditional trend lines, is that it allows the construction of a trading channel, prior to multiple pivot points at support and resistance lines. When the market is trending strongly, the price will stay primarily near the respective parallel line and gravitate to the median line on minor corrections. Traders can use the pullback to the median line as an opportunity to jump on board of the current trend. When prices fall through the median line, the assumption is that the price will move towards the opposite parallel line. If the second parallel line is broken, this is an early sign that the primary trend is in jeopardy. Conversely, if the price breaks out of the parallel line that is at the extreme of the range in the direction of the trend, then the security is said to be overbought or oversold. Traders should wait for the price to come back inside of the pitchfork, prior to attempting to take on new positions. Dr. Andrews believed that the price action will move to the median line 80% of the time while the primary trend is intact.

Charting Example of Andrew's Pitchfork

Andrews Pitchfork

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Commodity Selection Index (CSI) Definition

The Commodity Selection Index (CSI) is a momentum indicator that uses the ADXR component of the Directional Movement indicator to select commodities suitable for short-term trading.  The CSI was developed by Welles Wilder and was first published in the book New Concepts in Technical Trading Systems.  The higher the CSI, the greater the volatility and strength of trend.  Traders use the CSI is to find commodities with the highest volatility, because it has the greatest odds of quick gains.  The CSI is designed for short-term traders that have money management rules that account for the risks associated with highly volatile markets.

Commodity Selection Index Charting Example

Commodity Selection Index

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Qstick Definition and Formula

The Qstick indicator was developed by Tushar Chande, in order to determine the strength or weakness of a security over 'x" period of time. The Qstick indicator represents the moving average of the difference between the opening and closing prices of a security. A positive value means the security has had more net points up over "x" period, while a negative value means the security has had more net points down over "x" period. So, if a stock is up 10 points in one day, but down a total of 7 points the other 9 days, the stock will have a positive qstick value. The formula for the rate of Qstick is as follows:

Qstick Formula

Trading Rules - Qstick

The Qstick like many other technical indicators provides a number of trading signals based on the values of the readings and divergences. Below are three basic rules for trading with the Qstick.

Crossovers

The Qstick oscillates above and below the 0 line. A very basic trading principle is to buy a security on a cross up over the 0 line and to sell the security on a cross down through the 0 line. This technique will work well in sideways markets as the security is more likely to adhere to support and resistance levels.

Extreme Levels

The Qstick also provides extreme readings that can often call market tops and bottoms. The Qstick value has no upper or lower limits, so traders will have to look at previous tops and bottoms in the indicator when going counter to impulsive moves.

Divergence

The last trading rule for the Qstick indicator is to look for divergences between the price of the security and the indicator. So, traders will want to purchase the security if the Qstick value is increasing and the price is moving down. Conversely, traders will want to sell when the Qstick value is falling and the price is rising.

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Have you ever heard of the RVI technical indicator?

I am not talking about the relative vigor index, termed RVI or RVGI. I am referencing the relative volatility index!

In this article, I am going to share with you a few trading strategies you can use with this leading indicator.

Relative Volatility Index Definition

The relative volatility index (RVI) was developed by Donald Dorsey, who truly understood that an indicator is not the holy grail of trading.  The RVI is identical to the relative strength index, except it measures the standard deviation of high and low prices over a defined range of periods.  The RVI can range from 0 to 100 and unlike many indicators that measure price movement, the RVI does an exceptional job of measuring market strength.

Purpose of Relative Volatility Index

The relative volatility index was designed not as a standalone indicator, but as a confirmation for trading signals.  The RVI is most widely used in conjunction with moving average crossover signals.

Relative Volatility Index Buy and Sell Signals

Below are the rules that Dorsey developed for valid buy and sell signals when using the RVI:

• Buy if RVI > 50
• Sell if RVI < 50
• If you miss the first RVI buy signal buy when RVI > 60
• If you miss the first RVI Sell signal sell when RVI < 40
• Close a long position when the RVI falls below 40
• Close a short position when the RVI rises above 60

Using the Directional Relative Volatility Index Formula

Again, the relative volatility index indicator is not meant to be used as a standalone indicator for trading. Since the RVI is best suited for confirming trade signals, we should definitely combine the indicator with other trading tools and methodologies.

To this point, let’s now cover a number of approaches in further detail.

RVI and Fibonacci Retracement Levels

In this RVI system, we are going to watch for potential Fibonacci retracement levels and trade bounces/breakouts that are confirmed by the RVI.

We will place our stop loss order at the next Fibonacci level, in order to limit or losses.

Lastly, we will use simple price action techniques to take profits (chart patterns, candle patterns, support and resistance, trends, etc.). We can also exit the trade based on a contrary signal from the RVI indicator or from the Fibonacci levels.

The image below will show you how this trading strategy works:

RVI and Fibonacci Levels

This is the 2-minute chart of McDonald’s from Aug 26, 2015. In the bottom of the image, you will see the relative volatility index indicator, which we use to confirm Fibonacci signals.

We have identified a trend and the corresponding 61.8% retracement of this price action. Then, we notice the price beginning to bounce in a bullish direction.

At this time, the RVI indicator is still below the 50 level, but it quickly starts moving upwards. Seven periods after the bounce from the 61.8% retracement level, the RVI climbs above 50. This is our confirmation signal and we buy McDonald’s at $92.62. A stop loss order is then placed between the 61.8% and the 76.4% Fibonacci levels in the event McDonald’s loses steam.

After entering our trade, the next two candles are bullish and the price begins to expand rapidly as MCD approaches $95.

The next 3 to 4 candles begin to flatten out and we move our stop loss order to $94.50.

Ultimately, the price does not hit our stop and we exit the trade at $95.14, shortly before the market closes.

This trade accumulated profit of $2.52 per share while risking $0.52 (52 cents), thus representing a 1:5 risk-to-return ratio.

Let’s take a look at another trading strategy. This time, we focus our attention on Fibonacci breakouts and trend reversals.

Short - RVI and Fibonacci

This is the 3-minute chart of Pandora Media from Aug 24, 2015. At the bottom of the chart, you will see the RVI indicator. On the left hand side of the chart, you see a bullish trend, which we have used to identify our Fibonacci retracement levels.

After reaching the psychological area of $18 per share, Pandora’s price starts to roll over and we believe this could be a great short opportunity, if Pandora breaks the 61.8% retracement level.

We follow the move down and open a short position once the 61.8% retracement level is broken and the RVI indicator breaches 50.

The price keeps decreasing afterwards and notice how the bearish move is nicely contained by the blue down trend line.

The price continues lower and ultimately breaks the 100% retracement level. The 100% retracement level is a potential reversal zone, so we keep a close eye on the trade. However, until the price breaches the blue line or the RVI closes above 50, we have no reason to exit our short position.

The price decrease continues downward until reaching the 161.8% Fibonacci extension level. Shortly after reaching the 161.8% level, the price breaks the trend line, the RVI closes above the 50 level and Pandora eclipses its most recent high.  For all of these reasons, we exit our short position with a handsome profit.

Buying with the RVI and the ADX

This is a very interesting trade setup, which is a smart way of catching upcoming bullish moves.

It is very important to mention that the ADX indicator indicates trend strength and not direction.

Well, this is where the RVI comes into play. We will use the relative volatility index to determine if the stock is preparing to increase, as this strategy covers the long side of the trade. In other words, if the ADX is above 40 (or 50 if you want to get stronger confirmation), we will buy the security once the RVI also crosses above 50.

RVI and ADX

This is the 10-minute chart of Netflix from June 15, 2015. In the bottom of the chart, you see the relative volatility index and the average directional index.

First, the ADX crosses above 40, which gives us an indication that a strong trend is emerging. However, we don’t know the trend direction, because the price is moving upwards and the RVI is around 20, so we wait patiently.

Suddenly, the RVI switches above 50 and the price keeps its bullish pattern intact, while the ADX is still above 40, thus giving us our long signal.  However, let’s not forget about our stop!

A great place for our stop loss order would be the area below the bottom formed at the beginning of the trend, which we have marked - stop 1.

Notice that the price starts to move higher and a bullish uptrend line is formed.

We take advantage of the trend line and adjust our stop loss orders to the tests of this trend line.  As you can see, we adjust our stop loss three times in order to protect our gains as Netflix moves in our favor.

We exit the trade prior to the market closing in order to avoid overnight fees and the potential risk of a morning gap down.

This long trade on Netflix generated a profit of $6.00 per share.

Let’s now cover one more trading example.

RVI and ADX - Example 2

Above is the 10-minute chart of AT&T from Nov 15 - 16, 2015. At the bottom of the chart, we once again have the RVI and ADX indicators.

We are illustrating two days in this example, to further the point that at times you have to wait for multiple signals to line up before placing a trade. Trading isn’t always about taking action, sometimes the best course of action is just to sit tight.

Notice on the 15^th, the ADX put up a strong reading, but the RVI is still below 50.  Then the RVI finally crosses 50, but it’s with only 40 minutes left in the trading session, so we do not open a long position this late in the day.

The next day, the ADX is still above 40 and one hour after the market opens, the RVI switches above 50, providing a signal to buy AT&T. We go long and place our stop below the bottom of the prior the trend - stop 1.

After a two candle correction, the price continues increasing. This small correction creates a tiny bottom, which is a nice opportunity to adjust our stop loss order. We move the stop below the bottom of the trend line to lock in more profit - stop 2. A new price expansion appears followed by a correction. When the corrective move is finished, we adjust our stop below the bottom created by the correction - stop 3. There is one more price increase before the market closes, which allows us to adjust our stop yet again - stop 4.

During this trade, we generated profit of $0.40 (40 cents) per share, which equals 1.23% of profit.

Conclusion

• The Relative Volatility Index calculation measures the standard deviation of price highs and lows.
• RVI is a confirmation indicator and it is not meant to be a standalone indicator.
• Relative Volatility Index signals:
• Buy above 50
• Sell below 50
• Close long trades when RVI falls below 40
• Close short trades when RVI goes above 60.
• RVI works nicely with Fibonacci retracement levels:
• Take into consideration only Fibonacci levels signals, which are confirmed by the RVI
• Exit trades based on price action.
• RVI also works nicely with the ADX when trading long positions:
• Buy on signal match from the RVI and the ADX
• Stay in the market until crucial support is broken, or until the RVI goes below 40
• Constantly adjust your stop Loss order according to the price action.

The post Relative Volatility Index (RVI) – 2 Simple Trading Strategies appeared first on - Tradingsim.

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

Above is the chart of the advance decline ratio.

The line of the ratio fluctuates from an overbought to an oversold area. The arrow on the chart indicates how the price reacted to each overbought and oversold signal.

As you see, the advance decline ratio was able to predict short-term price moves of the S&P 500 pretty accurately.

Advance Decline Ratio Indicator

The advance decline line calculation attaches to the bottom (or the top) of the chart. Again, it consists of a single line.

The important level of the indicator is between 1-2.5 depending on the prior AD values. When the AD indicator starts trending above the average level, this indicates a bullish trend.

When the line stays below the average level, a bearish trend is present.

advance decline indicator

Above we have the 5-minute chart of Pandora Media from February 22-23, 2016. The average level here is the 2.5.

The image illustrates two tendencies. The first one is bullish and the second one is bearish. See the behavior of the AD Indicator during both trends. When the trend is bullish the AD line constantly breaks the 2.5 level. The line doesn’t stay above 2.5 for a long time, but it constantly creates impulses above and below the level. When the trend is bearish, the AD line simply stays below 2.5.

Trading with the A/D Line Indicator

Next we will go through a few basic entry and exit rules, which will assist your decision modeling process.

Tip#1 - Open Trades with the Advance Decline Indicator

The rules for opening long and short trades with the AD indicator are different. The reason for this is the inconsistent behavior of the indicator during bullish and bearish trends.

• Long Positions

You should open a long trade every time the advance decline indicator crosses the average level line upwards and stays above for at least 3 periods. When you see a bullish interaction with the average AD level, followed by 3 periods above, simply buy the stock.

• Short Positions

You should open short trades, when the AD indicator line breaks the average level downwards and stays underneath for at least 10 periods. This way you will distinguish the bullish trends where the AD line fluctuates above and below the average level from the bearish trends when the AD line is flat below the average level area.

Tip #2 - Close Trades with the Advance Decline Indicator

• Closing Long Trades

Long trades should be closed when the AD Line goes below the average level and spends at least 10 periods underneath.

• Closing Short Trades

You should close a short trade every time the AD line goes above the average level and stays there for at least 3 periods.

If you have noticed, the open and close position rules are mutually reinforcing. This means that each of these two rules triggers the other. In this manner, advance decline indicator trading is constantly holding you in the market. Therefore, you should first consider if this trading style is suitable to your personality as a trader.

Tip #3 - Advance/Decline Indicator Trading Strategy

Now we will apply the rules we discussed above into a real trading example. Have a look at the image below:

advance decline ratio and price decline

You are looking at the 5-minute chart of Apple from February 23, 2016. Below we have attached the AD Indicator. The image illustrates a short trade, which places us in the market during a whole trading session. The average level which the indicator gives us is 2.0

First we start with the market opening, which begins with a bearish gap at the opening bell. At the same time, the advance decline indicator switches below 2.0.

The Apple stock extends losses afterwards. Ten periods after the market opening we see the stock declining. Meanwhile, the AD indicator line is still below 2.0, which gives us a short signal. Fifty minutes after the market opening we are short on Apple.

The AD line decreases lower and holds its position below 2.0. In the middle of the trading session, the AD line starts increasing.

In the yellow circle, you will see the moment when the line breached the 2.0 level upwards. However, the AD line did not manage to stay above 2.0 for 3 periods or more. Therefore, we disregard the signal and we keep our trade open.

The AD line does not break the 2.0 level during the entire day. Therefore, we are forced to close our trade a few minutes before the market closes, because we are day trading.

Let’s now review a long trade with the advance/decline stock indicator.

long advance decline ratio trade

Now we are looking at the 5-minute chart of Netflix from May 25.

The average level displayed on the advance decline line chart is located at 2.0.

The image starts with the AD line switching above 2.0 for a few periods. However, after each of the interactions with the 2.0 level, the AD did not manage to stay above for 3 periods. Therefore, we disregard these signals.

The third time the AD line crosses above the 2.0 level, the indicator manages to stay above for 4 periods.

We open a long trade after the third period. As you see, the price starts increasing.

Meanwhile, the AD indicator starts fluctuating above and below the 2.0 level. Yet, the first 4 attempts the line doesn’t manage to stay below 2.0 for at least 10 periods. Therefore we disregard these as exit signals.

Our real exit signal comes when the AD line stays for more than 10 periods below the 2.0 level. This happens a couple hours after we bought NFLX. This is when we should close our trade and collect our profit.

Tip #4 - Advance/Decline Indicator + TRIX

Now, let’s discuss another indicator you can trade with the advance decline indicator - the TRIX (Triple Exponential Average) oscillator.

The TRIX indicator consists of a single line, which fluctuates below and above a zero level. We will use the TRIX to confirm entry signals which come from the advance decline stock indicator.

When we get a long signal from the AD tool, we will first need to see the TRIX above the zero level in order to go long. Contrary to this, if we get a short signal from the AD, we will first need to see the TRIX line below the zero level in order to go short.

In this manner, the TRIX is used as a validation signal for entering trades. The exit signal stays the same. We will only use the AD tool to identify closing signals. Let me now show you how the advance decline trading strategy works.

advance decline ratio and TRIX

Above is the 5-minute chart of Yahoo from November 18, 2015.

The average level of the advance decline chart is located at 2.0, so this is what we will use as a trigger line.

The image starts with a price increase. Meanwhile, the AD tool has an impulse move above the average level at 2.0. However, the line only stays above for a few periods and as you know, we need at least 3 periods in order to consider this a valid long signal.

Furthermore, the TRIX line is below the zero level at this point.

Six periods later, the TRIX line crosses the zero level upwards.

One period later, the AD line crosses above the 2.0 level and we start to count the periods.

Fifteen minutes later (3 periods), the AD line is still above 2.0. The TRIX line holds its position above zero and is steadily increasing.

Therefore, we realize this is our long signal and we buy Yahoo as shown on the image.

YHOO then begins to increase. The TRIX line also increases following the price action.

However, the advance decline line hops below the 2.0 level. According to our strategy, we need to see the AD line below the average level (2.0) for at least ten periods before we exit our trade. For this reason, we start to count every finished period starting from the moment indicator flipped below 2.0. For 9 periods, the AD line stays below 0.0 and then it switches above. For this reason, we keep holding our trade.

Almost an hour later, we are forced to close our long position due to the end of the trading session.

After all, we are day trading and we need to close all trades during market hours.

Conclusion

1. The advance/decline ratio shows the ratio of advancing issues to declining issues.
2. The advantage of the AD ratio is that it is a constant number
3. The advance decline ratio formula is: advancing Issues / declining Issues
4. The following values could be used for calculating the market’s trend:

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

5. A good AD tool for trading single stocks is the advance/decline indicator. Its basic signals are:

• Go long and close short positions when the AD line switches above the average value and stays for at least three periods there.
• Go short and close long positions when the AD line switches below the average value and stays there for at least ten periods.

6. A good oscillator to combine the AD indicator with is the TRIX. It will assist the entry confirmation when trading with the Advance/Decline indicator:

• Go long when you get the respective signals from the AD indicator, only if the TRIX is above zero.
• Go short when you get the respective signals from the AD indicator, only if the TRIX is below zero.
• Close your trades based only on the AD indicator.

The post 4 Tips for Day Trading with the Advance Decline Ratio appeared first on - Tradingsim.

Fibonacci Arc Definition

Fibonacci arc is a technical analysis indicator used to provide hidden support and resistance levels for a security.

A fibonacci arc is constructed by first drawing a trend line between two swing points on a chart.  These two points should be between a clear peak and trough on the chart.  Once the line is drawn, key fibonacci levels are placed on the chart at 38.2%, 50%, and 61.8% retracement levels.  An arch is then drawn at each respective level to generate the arching angles on the price chart.

Trading with Fibonacci Arcs

Breakouts

Trading with fibonacci arcs is done by first identifying the key fibonacci arc levels.  The next step is to monitor how the stock performs at these key levels.  If the stock breaks above both a recent price high and an arc resistance level (38.2%, 50% or 61.8%), a buy order should be placed.  Traders should then look for the next higher fibonacci arc level to lock in profits, or sell the position outright.

Reversals

Another popular method when trading fibonacci arcs is to look for a failure at fibonacci arc levels.  Since arc levels are not followed by many traders, these are considered "hidden" levels on the chart.  For example, a trader can wait for a break above the 61.8% retracement level and then close back above the arc.  A short position should be entered after a move below this reversal bar.

Fibonacci Arc Trading Example

Below is a fibonacci arc trading example, courtesy of VT Trader.  This example is on a 30-minute level over a two-day period.  Notice how a trough and peak are used on the chart to draw the trend line which the fibonacci arcs are based upon.  Then notice how as the price reacts from the peak it sells off sharply down to the 61.8% arc retracement level.  This hidden arch level initially acted as support, but as the EUR/USD closed below the arc level, it eventually became resistance.

Fibonacci Arc

Fibonacci Arcs Trading Approach

Now that you are familiar with fibonacci arcs, we will now dig further into how to trade with the indicator.

After all, it is not enough to identify patterns on the chart. You should also know how to enter and exit trades based on signals from the indicator.

Entering Trades - Fibonacci Arcs

There are two types of price moves, which you can attempt to catch with the fibonacci arcs tool. These are price moves in the direction of the trend and price moves against the trend.

Trading Fibonacci Arc Breakouts against the Trend

fibonacci arc

The chart above is of a bullish trend that enters a reversal phase.

You will want to use the high and low of this pattern to create the fibonacci arcs.

On the way down the price action breaks the 23.6%, 38.2%, 50.0%, and 61.8% fibonacci arcs. See that after each breakout in the arcs the price decreases further. Each of these breakouts gives you an opportunity to trade against the primary trend.

As you can see, this method would have worked all the way down as the stock ultimately retraced the entire move.

Trading Bounces using Fibonacci Arcs

This trading practice involves trade entries after the price bounces from one of the arcs in the direction of the trend. Imagine the price breaks a trend and goes to one of the fibonacci arcs. If you see the price bouncing from the arc, you should trade the stock in the direction of the bounce.

Pullback Trade - Fibonacci Arc

Above is a classic example of a price bounce from a Fibonacci Arc.

Again, we use the high and low of the pattern to create the fibonacci arcs.

The price starts decreasing and it breaks the 23.6%, 38.2% and 50.0% fibonacci arcs. Then suddenly the price action touches the 61.8% arc and creates a small bullish candle, indicating a bounce.

We use this bounce as an opportunity to enter the market and place a long trade.

As you see, the price finds support at the 61.8% arc. The stock then begins to resume its bullish move higher.

Stop Loss - Fibonacci Arcs Trading

You should always protect your trades with a stop loss, regarding of the method. This same rule applies to Fibonacci arcs – no exceptions. After all, the market will not always move in your favor.

Therefore, you should never let the market surprise you.

Since there are two types of entries when trading with fibonacci arcs, we will approach two types of stop loss order positioning.

Stop Loss - Fibonacci Arc Breakouts

When you see the price breaking a fibonacci arc, you are supposed to enter the market in the direction of the breakout. In this manner, you are trading against the previous trend.

To position your stop loss, you should pick a price peak, which is located somewhere above the broken arc.

Let’s walk through a real-life example, to clarify the placement of the stop loss order.

Fibonacci Arc - Stop Loss

The red horizontal lines on the image represent the proper location of the stop loss orders on these potential trades. See that the second and the third trade share the same level for a stop loss order. The reason for this is the weak downward move after the second short signal.

The bottom line is that you are protecting your gains as the stock moves higher in your favor. This my friend is how you make money in the market.

Stop Loss - Fibonacci Arcs Bounces

This time we will position the stop loss orders beyond the levels, which the price bounced off the fibonacci arc.

Fibonacci Arc - Stop Loss for Bounce Trades

Above you see the bounce from the 61.8% fibonacci arc we discussed a couple examples ago. The red horizontal line represents the proper location for your stop loss order. See that we use the small range, which the price creates in the time before the bounce. If the price decreases to this level, it will definitely be outside the 61.8% arc.

Profit Taking - Fibonacci Arcs

Scalping for Moves between the Arcs

This profit approach includes trading the price moves from arc to arc. No matter if the price has broken, or bounced from an arc, you should stay in a trade until the price reaches the next arc.

For example, if the price breaks through the 23.6% fibonacci arc, you should open a trade and stay in the position until the price touches the 38.2% arc.

Trading until the Stock is Trending in Your Favor

Some traders are very flexible on their profit taking approach and like to let the stock run in their favor. In this manner, they prefer to stay in the trade until they receive a contrary trading signal from the stock.

After all, why exit a trade, which is going more and more in your favor?

This means you essentially ride the wave until the price goes against you.

While this approach will yield the largest gains, the success rate will be relatively lower.

This is because the price will likely reverse at some point and retest your entry. As a responsible trader, you will need to determine which profit taking approach works best for your personality.

I prefer to go with the a high winning percentage.

This is because I am a sore loser and I still get upset when things do not go my way.  Similar to the way I felt when I was 5 years old and my brother would beat me in a game.

Hey, don't judge me; I am what I am.

Trading Strategy - Fibonacci Arcs

We will now combine the rules we discussed above into a complete fibonacci arcs trading system.

Fibonacci Arc - Trading Strategy

Above you see the 5-minute chart of IBM from Mar 29, 2016.

We first anchor our fibonacci arcs based on the high and low of the range.

See that the price starts moving sideways after reaching a swing high.

The range brings the price through almost all the arcs on the chart. However, this ends when the price reaches the 161.8% fibonacci extension arc. After touching this arc, the price bounces upwards directly above the 100% fibonacci level.

We get a nice signal for a long position and we buy IBM. The stop loss should be located right below the bounce, which is also the lower level of the previous price range.

The price continues its increase after we enter the market. An hour later, the price creates a top and begins a minor correction. Then we see another bullish bounce and the creation of a lower top on the chart.

This lower top is the first indication that the bullish move might reverse. The stock then goes into a small range and creates a clear support area.

After creating the lower top, the price decreases through the support level and we close our long IBM trade.

Now let’s review a fibonacci arc trade with a bearish trend.

Fibonacci Arc - Stop Loss Example

You are now looking at the 3-minute chart of Netflix from May 19, 2016. The chart begins with a bearish trend, which we use to position our fibonacci arc indicator.

After the price finishes the bearish impulsive move, it starts a consolidation, which begins to produce higher highs. The first bullish impulse leads the price action to the 50.0% fibonacci arc. The price then bounces upwards and reaches the 100% Fibonacci level.

However, this is not the important price move. The second bullish impulse brings the price to the 161.8% Fibonacci extension arc and creates a little bearish bounce. This is the right moment to sell NFLX.

As you see, the price starts a rapid decrease, which goes below the 100% Fibonacci level. Then the price enters a consolidation phase. As you see, the consolidation resembles a triangle, where the lower level is flat. The tops of the consolidation are lower. In this manner, the triangle breaks downwards and we keep our short trade.

The price decrease continues to $88.30 per share, when suddenly the downward move halts and a trading range ensues.

We mark the upper level of the consolidation with a resistance area as shown on the image above. The further price action crawls right below this resistance level.

Netflix attempts another bearish move, which proves unsuccessful. The price returns to the resistance and breaks to the upside. This is the ultimate exit signal and we close our short position with Netflix.

Conclusion

1. The fibonacci Arcs indicator is used to find hidden support and resistance levels on the chart.
2. It has the same levels as the other fibonacci tools (extensions, retracements, etc.)– 26.3%, 38.2%, 50.0, 61.8%, etc.
3. When you use the fibonacci arcs you can take two types of trades:

• Arc Breakouts
• Arc Bounces

4. When you trade arc breakouts, you should enter the market in the direction of the arc breakout. In this case, you should place a stop beyond a crucial peak created in the time of the breakout.
5. When you trade arc bounces, you should enter the market in the direction of the bounce. In this case you should place a stop loss beyond the peak, which is being created with the bounce.
6. You have two take profit options when you trade fibonacci arcs:

• The first one is to scalp the stock when it reaches the next fibonacci arc. Traders open and exit trades from arc to an arc, hopping in and out of the market. This strategy has a high success rate, but the gains are relatively small.
• The second method is to trade the stock until it stops trending in your favor. This technique involves the usage of simple price action techniques. If you implement this profit taking strategy, your fibonacci arc success rate will be relatively low; however, the profit from each trade will be much higher relative to scalping.

The post Definitive Guide for Day Trading Fibonacci Arcs appeared first on - Tradingsim.

Would you like to know when the price of the stock you are trading is likely to find support or resistance and about to reverse? Yes? Great! You are in luck that J. Welles Wilder Jr. worked hard to write a book called New Concepts in Technical Trading Systems, where he explicitly introduced a technical indicator that does exactly that. It is called the Parabolic SAR, which stands for Stop And Reverse.

Today, we are going to show you what the Parabolic SAR is, how it is calculated, and how you can include the Parabolic SAR into your day trading strategy.

Figure 1: Parabolic SAR is plotted on the Price Chart as Dots that Appears Above or Below the Bars

If you have a good pair of eyes, you can identify the Parabolic SAR indicator from across the room. Most popular charting packages include the Parabolic SAR and it is plotted on the price chart of the stock as dots that appear above or below the candlesticks or bars.

During an uptrend, you will find that the Parabolic SAR dots appear below the price. On the other hand, when the price remains in a bearish trend, you will find that the Parabolic SAR dots appear above the price.

If you pay attention to Figure 1, you would find that the Parabolic SAR dots converge with the price momentum. Meaning, when you see a strong trend and price is going up or down quickly, the gaps between the dots will widen. By contrast, when the price is consolidating within a range, you would find that the Parabolic SAR dots are plotted close to each other.

Understanding the Parabolic SAR Formula

Well, you really do not need to know the actual formula of any technical indicator in order to build a trading strategy, but it pays to fully understand why those Parabolic SAR dots appear. Also, if you want to build a Parabolic SAR calculation excel file to build a decision support system for your day trading, you would need to know the Parabolic SAR formula.

Anyway, here is the formula that is used to calculate the Parabolic SAR values:

SAR_n+1= SAR_n + α (EP – SAR_n)

In the Parabolic SAR formula, the SAR_n is the current period and as +1 indicates, the SAR_n+1 is the next period’s SAR value. During an uptrend the EP is the highest price in the trend, which would be the high of the top most candlestick or bar in the trend.  On the other hand, you can be pretty sure that the EP would represent the low of the lowest candlestick or bar in a downtrend.

Since the Parabolic SAR dots only appear either above or below the price, it is not a difficult task for you to identify what the EP value is representing. Right? If you still have any confusion, feel free to leave a comment and we would be happy to help you understand the formula better.

The most important variable in the Parabolic SAR settings is the α, which represents the acceleration factor in the formula.

When you try to add the Parabolic SAR indicator in the chart, your charting package would usually set the α value to 0.02. You see, during an uptrend or downtrend, when the price makes a new high or low, the acceleration factor is increased by 0.02. This is the reason why the gaps between the Parabolic SAR dots get larger during a strong trend and the size of the gaps contract during a price consolidation.

Although the default acceleration factor is set to 0.02, most charting packages would allow you to change it. You may wonder why you would ever need to fiddle with the acceleration factor. Well, some stock prices are more volatile than others and depending on the time frame you choose, optimizing the acceleration factor can indeed improve your trading performance.

For example, in the Tradingsim, you can replay the price action with different SAR acceleration factors in order to find the optimum value and forward test the market it to see if the new value makes any major difference in generating Parabolic SAR buy signals or Parabolic SAR sell signals. If you see a positive result, you should customize the SAR formula to fit the characteristic of the stock’s price action.

Example of Day Trading with Parabolic SAR Buy Signals

Figure 2: Parabolic SAR Buy Signals are Generated When the Price Moves Above the Upper Dot

Day trading with a Parabolic SAR strategy is pretty easy as these dots acts as dynamic support and resistance levels. During a downturn, the Parabolic SAR dots act as dynamic resistance levels and when the price moves above the upper Parabolic SAR dot, it generates a buy signal.

In figure 3, you can see that when Apple’s price was trending down on the 5-minute time frame, the Parabolic SAR dots went down with it and as long as the price did not move above the upper dots, the downtrend continued. However, when the price moved above the Parabolic SAR dot, the bearish momentum diminished from the market. Then, the Parabolic SAR indicator generated a buy signal that turned into a bullish trend.

Example of Day Trading with Parabolic SAR Sell Signals

Figure 3: Parabolic SAR Sell Signals are Generated When the Price Moves Below the Lower Dot

Similarly, you would find that during an uptrend in this 5-minute time frame of Apple Inc, the Parabolic SAR dots acts as dynamic support levels and when the price moves below the lower Parabolic SAR dot, it generates a sell signal.

In figure 4, you can observe that when the price was trending up, the Parabolic SAR dots went up along with it and as long as the price did not move below the lower dots, the uptrend prevailed.

However, as soon as the price moved below the lower Parabolic SAR dot, the bullish momentum diminished from the market and the Parabolic SAR indicator generated a sell signal. On this occasion, it was a small retracement, but nonetheless, you could have made quick profits out of this small swing.

Developing a Proper Parabolic SAR Strategy for Day Trading

If you understood how the Parabolic SAR indicator is calculated and how to properly apply a Parabolic SAR strategy in day trading, you should be very excited. However, you should also know that there are a few pitfalls to watch out for when you are depending solely on the buy or sell signals generated by the Parabolic SAR indicator.

First, due to the EP values, that measures the highest highs or the lowest lows during an uptrend and downtrend, respectively, the Parabolic SAR indicator generates the best signals during a trending market. But, when the market is consolidating, it would likely generate lots of false signals that can get you in trouble.

Figure 4: Including a Trend Strength Indicator like the DMI In the Chart Can Vastly Improve the Quality of Parabolic SAR Signals

Therefore, it is better that you consider including a technical indicator in the chart, which can measure the strength of the trend. For example, the Directional Movement Index indicator can show you if the stock is in a consolidation pattern or trending. This way, you can trust the Parabolic SAR buy or sell signals, and safely ignore the Parabolic SAR when the average line of the Directional Movement Index indicates a range bound market condition.

However, professional day traders often use the Parabolic SAR to set stop loss instead of generating buy or sell signals as well. If you are not sure about the trend’s strength, instead of placing a buy or sell order based on the Parabolic SAR signal, you can use the lower or upper Parabolic SAR dots as a trailing stop loss. Once the price moves above or below the dot, regardless if the price starts a new trend in the opposite direction or not, you can be certain that the prevailing trend is about to take a pause. It is always a smart idea to get out of the market at this point.

Conclusion

The Parabolic SAR indicator is a great tool to have on your day trading chart. If you develop a proper Parabolic SAR strategy around some of its pitfalls, you can improve the accuracy of your existing trend following strategy. In addition, by using the Parabolic SAR dots as a trailing stop loss for your open positions, you can easily figure out when the trend is likely to reverse and protect your profits.

Regardless how you choose to implement the Parabolic SAR indicator in your day trading, if you integrate it with other technical indicators, your monthly statement from the broker would likely make you just a bit happier, one dot at a time.

The post How to use the Parabolic SAR Indicator to identify Day Trading Signals appeared first on - Tradingsim.

Whether you want to believe it or not, Fibonacci levels play a critical role in defining support and resistance levels when day trading.

The one topic not covered much in the trading community is the impact or rather influence Fibonacci extensions have on day trades.  In this article, we are going to cover foundational topics related to Fibonacci extensions and how you can incorporate straightforward tactics into your trading regiment.

Fibonacci Extensions Definition

Fibonacci levels are a standard measure for support and resistance levels within the market. This levels are calculated by analyzing the retracement levels between two swing points. The next question we have to ask ourselves as traders, is what happens when price exceeds the very swing points we use to calculate our fibonacci levels? At what point do we look to exit our position? The key to these questions are fibonacci extensions. Fibonacci extensions provide price targets that go beyond a 100% retracement of a prior move. The levels for fibonacci extensions are calculated by taking the standard fibonacci levels and adding them to 100%. Therefore, the standard fibonacci extension levels are as follows: 138.2%, 150%, 161.8%, 231.8%, 261.8%, 361.8% and 423.6%.

Identifying Fibonacci Extension Levels

The first step in drawing fibonacci extension levels is to identify two clear swing points. These point should be in relation to both your current timeframe and length of trend. In the below example we will be reviewing the fibonacci extension levels for Provident Bankshares (PBKS). As you can see, the stock was able to exceed its high of $18.76. Once PBKS exceeded this prior swing high, the stock began an impulsive move up that would not face any real resistance until achieving its 261.8% retracement level.

Fibonacci Extensions

Trading at Fibonacci Extensions

The last part of the fibonacci extension equation, is what to do when the asset hits the respective target. The first inclination is to immediately close your position at the next fibonacci level. Traders will have to fight this urge and wait to see how the stock reacts at these fibonacci extensions. Remember, the stock has exceeded previous swing highs and could very well start an impulsive move.

#1 - Fibonacci Extension Breakout + Awesome Oscillator

The methodology behind this trading strategy is to confirm breakouts above or below Fibonacci extensions with the awesome oscillator (AO).

The most important AO signals are:

• Zero Level Crosses

This is when the bars of the awesome oscillator move from positive to negative territory and vice versa.

• Saucer

Saucers are specific formations on the AO indicator itself. A bullish saucer occurs when there are two red bars, where the second one is lower, followed by a higher green bar. At the same time, the bearish saucer has two green bars, where the second one is lower, followed by a red bar.

• Trend Lines

Trend lines could be placed on the awesome oscillator. In this manner, if an AO trend is broken, it gives a long or short signal, depending on the direction of the trend and the breakout.

• Chart Patterns

Yes, that is correct. Chart patterns can be found on the AO. Some of these are double top, double bottom, triple top, triple bottom, head and shoulders, triangles, etc.

Since we now discussed how to set entry points with Fibonacci extensions and AO we now need to determine trade exit rules. Here, I recommend you not to over complicate things. It is enough to see the AO bars cross the zero level in order to exit the market. In other words, if you are short, you need to see the AO closing a bar above zero. If you are long, you need the AO to close a bar below zero.

Let’s now see the Awesome Oscillator in action with Fibonacci extensions:

Fibonacci Extensions + Awesome Oscillator

This is the 10-minute chart of Twitter from Aug 27 – Sep 4, 2015. In the beginning of the chart you will see a small bearish trend. This is where we develop our Fibonacci retracement levels. As you see with the market opening on Aug 31, Twitter creates a big bullish gap through the 1.618 Fibonacci extension level. Twitter then continues moving strongly and the price is able to breach the 2.618 extension level.

We see no sell signals from the AO, so we hold. At the same time, the AO creates a double top (blue). Meanwhile price breaks in a bearish fashion through the 2.618 extension. AO supports the bearish move with the double top and break below zero and we short Twitter.

On its way down, the price finds support at the 1.618 extension level. AO gives us a bearish saucer, which signals us to keep our short trade. The awesome oscillator also creates a bearish trend (purple line). In the red circle we see the moment when the AO breaks the bearish trend. This is when we close our position. This trade brought us a profit of 90 cents per share.

Twitter drops to the 1.00 Fibonacci level afterwards. The price tests the level for a while and a new bullish trend appears. Ultimately, the price breaks the 1.618 extension level in a bullish direction. At the same time, the AO crosses above zero. We recognize these two signals and go long.

Twitter starts a consolidation around 1.618; meanwhile, we get three bullish saucers from the AO, which supports our long position. After the third saucer, the price explodes in a bullish fashion reaching the 3.618 Fibonacci extension level. At the same time, the AO reaches 1.00, which is considered high enough to close any long position. We exit the market with a gain of $1.16 per share.

#2 - Fibonacci Extension Breakout + Know Sure Thing Indicator (KST)

In this Fibonacci retracement strategy, I will combine Fibonacci extension breakouts with buy/sell signals from the KST indicator.

When the stock price breaks a Fibonacci extension, I will first confirm it with the KST before entering the market. When I see an extension break, I need the two KST lines to cross upwards in order to go long. Conversely, I need the two KST lines to cross downwards to go short. This is when we are going to enter the market. We hold the position as long as the KST supports the price direction. We exit the market when the KST lines cross in the opposite direction.

The KST indicator could also indicate an underlying divergence in the stock price. It works the same way as with the awesome oscillator with the one difference that the KST has lines and not bars. The price could move upwards while the KST creates lower tops or bottoms – bearish divergence. At the same time, the price could move downwards, while the KST tops and bottoms close higher and higher – bullish divergence.

Let me now introduce you to the Fibonacci retracement extension levels with the KST indicator:

Fibonacci Extensions + Know Sure Thing Indicator

This is the 10-minute chart of Microsoft from Aug 18-21, 2015. We have placed the Fibonacci retracement levels on a small trend shown in the upper left corner. The price starts dropping and it breaks the 100% Fibonacci level.

At the same time, the KST lines cross in a bearish direction. The two signals confirm the price action and we go short. The price drops to the 1.618 Fibonacci extension level and the KST lines then cross in a bullish direction. We close our short position. This trade brought us 20 cents per share profit in 3 hours.

Microsoft increases afterwards reaching the 61.8% Fibonacci retracement level. When the price drops again, it breaks the 1.00 Fibonacci level in a bearish direction. At the same time, the KST lines crosses downwards. We get two new matching bearish signals and we short MSFT again. Price drops through the 1.618 retracement level like a rock. Then Microsoft finds support at the 2.618 Fibonacci extension level, while the KST lines cross upwards. This is our signal to close the trade with a profit of 60 cents per share.

After consolidating for a while, MSFT breaks the 2.618 extension level in a bearish fashion at the same time the KST lines cross downwards.  Based on this action, we open another short position.

An impulsive move down begins and we were able to book $1.70 per share in profits.

#3 - Fibonacci Extensions + Volume

As I have said many times, you should always consider trading volume when assessing any trading opportunity.

When you see high volume, this means bulls and bears are fighting against one other for market dominance. Once one side prevails, the trend will likely follow in their desired direction. Therefore, if there is strong volume in conjunction with a Fibonacci extension breakout, this gives us further validation of our trading signal.

Fibonacci Extensions + Volume

This is the 5-minute chart of Coca-Cola from May 27-29, 2015. I have placed a Fibonacci retracement on a small bullish trend in the upper left corner. At the bottom of the chart, you will see the volume Indicator. The chart and the volume indicator show four examples of price moves due to high volume.

The first case is when the price approaches the 0% Fibonacci retracement level for the third time. Volume increases and the price drops quickly to the 1.618% extension level. Coca-Cola finds support, volume increases and the price starts to move in a bullish fashion.

When KO reaches the 0% retracement again, volume begins to increase to the downside.  This time Coca-Cola was able to break the 1.618% retracement level to the downside.  Therefore, where the 1.618% was previously support, this level will now act as resistance once breached.

Which Fibonacci Extension Trading Strategy is the best?

I believe the KST is the most straightforward approach out of the three day trading strategies covered in this article. The signals are crystal-clear and if you want extra confirmation, you can add volume into the mix.

Thus, the best strategy is combining Fibonacci extensions, KST and the volume indicator.

In Summary

• Fibonacci Levels act as standard support or resistance levels.
• Fibonacci extensions are the levels, which go beyond 100% Fibonacci retracement.
• In order to determine Fibonacci extensions, you should identify a trend with a corrective move.
• If price reaches a Fibonacci extension level, we need to confirm subsequent moves with another instrument.
• Some of the useful tools for trading Fibonacci extensions are:
• Awesome Oscillator
• Know Sure Thing Indicator
• Volume Indicator
• I believe the most useful way to trade Fibonacci extensions is by combining the KST indicator with the volume indicator.

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TEMA Definition

TEMA stands for Triple Exponential Moving Average and is used to identify trends in the market.   It was developed by Patrick Mulloy and was first published in the 1994 issue of Technical Analysis of Stocks and Commodities.  Mulloy discovered that by developing a unique composite of a simple exponential moving average, double exponential moving average and a triple exponential moving average, he could reduce the amount of lag between the indicator and price action.  The TEMA is a custom indicator and is not included in many trading platforms.

Trading with the Triple Exponential Moving Average

Mulloy discovered that by modifying the MACD to with a TEMA input, it produced better results than the standard MACD, which is based on the exponential moving average.

Triple Exponential Moving Average Formula

Below is the formula for the triple exponential moving average:

(3 * EMA) - (3 * EMA of EMA) + EMA of EMA of EMA)

Where:

EMA = n-day exponential moving average

TEMA

Above is a 5-minute chart which includes a 50-period TEMA and a 50-period SMA.

The green line is the triple EMA and the blue line is the simple moving average. Notice that the two indicators include the same number of periods, but you can see the difference in their plots.

Triple Exponential Moving Average Signals

As you probably guess, the basic signal of the TEMA trading indicator is the same as with any other moving average – the price crossover. When the price breaks the triple exponential average, we get an entry or exit signal in the respective direction.

Bearish Cross

We have a bearish TEMA cross when the price closes below the indicator.

If the price breaks the TEMA in a bearish direction, we get a short signal. This means that any open long trade should be closed. At the same time, short trades should be considered.

Bearish TEMA Cross

As you see in the above image, the price closes below our triple exponential line. This creates the short signal on the chart.

Bullish Cross

Bullish TEMA Cross

As you see, after the bullish TEMA crossover, the price starts a new increase in the direction of the cross.

TEMA Crosses

Now you are looking at a 2-mintue chart of Ford Motor company. The green line is a 50-period triple EMA where we localize 4 trading signals.

The first signal comes with the first green circle when the price closes a candle above the TEMA.

The second signal comes after a price correction, which leads to a steady decline. As you see on the chart, there is a big bearish candle, which closes below the TEMA.

At the end of the bearish trend, the price begins to hesitate and then closes above the TEMA.

Do you have a handle on this yet?

I don’t want to paint this perfect picture, as there are a ton of false signals produced by the market.

For this reason, we will now discuss how to distinguish real TEMA signals from false ones.

Triple Exponential Moving Average Strategy

Now that you are familiar with the TEMA signals, we will discuss a few trading strategies.

A key tenet of the trading strategy is the use of additional trading indicators to filter out false signals.

TEMA + Volume Indicator

This is a classical setup where we combine the TEMA trading instrument with the good ole volume indicator.

The idea of this strategy is to take signals that include high trading volumes.

As you probably know, the market is trending when volumes are high.

During low volumes, prices are likely to range and not trend. This means that low volumes are the major cause for the sideways price action.

For this reason, TEMA signals, which appear during lower trading volumes tend to fail.

For this strategy, we will enter the market only when TEMA price crossovers with higher trading volumes.

We will then hold our trades until the price action breaks the TEMA in the opposite direction.

TEMA + Volume

Above is the 2-minute chart of General Motors from Apr 26, 2016. The green line on the chart is the 50-period triple EMA. The red and green bars at the bottom of the chart are our volume indicator.

The chart starts with a range consisting of light volume. Notice that for the crosses beneath and above the TEMA, we ignore these signals, due to the light volume.

Suddenly, volumes in GM begin to increase and the price forms a bigger bullish candle.

At the same time, the price begins to move above the TEMA and the bullish candle imply that this trend is likely to be bullish. Therefore, we open a bullish trade with the closing of the bullish candle as shown on the image.

The price continues higher after opening the position.

The first correction of the bullish move tests the area of the 50-period TEMA but the price is able to hold up under the selling pressure.

The second correction actually breaches the TEMA, but the price was unable to close beneath the TEMA.

Therefore, this signal should be disregarded. GM then makes one final push higher and ultimately closes beneath the TEMA.

Once the price closes beneath the TEMA, we would need to exit the position.

TEMA + Volume Weighted Moving Average (VWMA)

The VWMA acts as a standard moving average on the chart. The difference between the VWMA and the simple moving average, is that the VWMA places emphasize on periods with higher trading volume. This makes it the perfect tool to combine with the TEMA.

We will use the same 50-period TEMA in a combination with a 25-period VWMA (TEMA/2). We will open trades only when the TEMA and the VWMA cross. The trades should be in the direction of the crossover. We will hold each trade until the price action breaks the volume weighted MA in the opposite direction.

TEMA + VWMA

Above is the 2-minute chart of General Electric from Apr 27, 2016.

The green line on the graph is the 50-period TEMA. The blue line is the 25-period VWMA. The image illustrates a long trade with the GE stock, taken by signals from the TEMA and the VWMA.

The chart above starts with a price increase and a bullish crossover between the two indicators. This generates a long signal between the triple EMA and the volume weighted MA. Following our strategy, we open a long position.

The correction which comes after the second price impulse brings the price below the TEMA.

However, the VWMA is still untouched. Following our strategy’s exit rules, we hold the trade until the price closes a candle below the VWMA.

Notice in this case, the TEMA fails to provide a reliable exit signal. The VWMA on the other hand contains the price in a better way than the TEMA. The reason for this is that the VWMA indicator is a volume-based moving average. In this manner, the indicator gains additional inclination when volumes are higher.

This is how the VWMA indicator adapts to the dynamic moves on the chart.

The next price action leads to a new increase and the GE stock reaches the highest point of its bullish trend.

The stock then enters a corrective phase. On the way down, General Electric breaks the TEMA line.

Even though we had a break, we stay until we see a breakout in the volume weighted line. This happens 16 minutes later when a bigger bearish candle appears on the chart. We get a valid exit signal and we close our long trade on the GE stock.

Which is the Best Triple Exponential Moving Average Strategy

I believe this would be the second strategy – TEMA + VWMA. The reason for this is that the VWMA gives all the additional data we need to enter a trade. This is average price and volumes reaction.

The TEMA plus the volume indicator is another strategy for trading with TEMA; however, the entry signals are sometimes hard to determine. The reason for this is that in many cases, volumes might be confusing. If the volume bar is somewhere in the middle, is the trading volume low, or high? This sometimes confuses and fails the traders who attempt to enter a position.

Conclusion

1. The Triple Exponential Moving Average was developed by Patrick Mulloy.
2. TEMA helps you identify trends.
3. The TEMA is a triple smoothed exponential moving average, which reduces the lag between the indicator and the price action.
4. TEMA is a custom setup, which is missing in many trading platforms.
5. The basic TEMA signals are:

• Bullish Crossover: A candle is closed from the upper side of the TEMA line
• Bearish Crossover: A candle is closed from the lower side of the TEMA line

6. Two of the best TEMA trading strategies are:

• TEMA + Volume Indicator: We enter trades on TEMA crossover + higher volumes. We exit trades when price breaks TEMA in the opposite direction.
• TEMA + VWMA: We enter trades on TEMA and VWMA crossovers in the direction of the cross. We exit trades when price breaks the VWMA in the opposite direction.

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Renko Charts Definition

Renko charts can trace their origins to Japan and were first introduced to the West by Steve Nison in his book "Beyond Candlesticks". The actual word renko is derived from the Japanese word renga, which means bricks. Renko charts are similar to kagi charts and the three line break charts except that the renko chart is drawn in the direction of the primary trend and have a fixed size. Renko charts are also similar to point and figure charts as each brick is the same size depending on the minimum amount per brick. So, in order to generate an opposite color, the fixed brick size of the Renko must be exceeded. This of course classifies renko charts as a lagging indicator and in choppy markets can lead to a number of false signals.

Renko Chart Example

Renko charts are used to determine potential changes in price trend. Below is a chart pattern example with renko bars.

Renko Chart

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