Gann

The trading concepts used by William Delbert Gann or W.D. Gann as he is fondly called is a name in the financial markets that instantly brings intrigue and mystery, not to forget the fact that Gann's concepts of trading are vast in itself.

Gann as primarily a trader know for his market forecasting abilities combining a mix of geometry, astrology and ancient math techniques. Gann started trading at the age of 24 and was religious by nature, reflected in some of his work. Gann was also a 33rd degree Freemason, to which some attribute his knowledge of ancient mathematics.

For the most part, Gann's works have been open to interpretation with many of his methods of trading being far from simple. Therefore, to trade based off Gann's methods requires some serious practice and significant effort on the part of the day trader.

Unlike trading with technical indicators where you can buy or sell when some variables are met, with Gann's methods trading is not as simple as it seems, despite the fact that many have attempted to simplify Gann's trading methods, which is debatable. To put some perspective, it is a lot easier for a complete beginner to trading to understand the concepts of trends and trade with moving averages than understanding the entire concept of Gann’s methods and putting it to the test in the markets.

This, besides the point that there are so called many "Gann experts" where each claims to have the right understanding of Gann's methods, makes it even more complex for the average day trader. There are quite a few online calculators that seem to simplify Gann analysis for you, but it is risky to say the least.

One of the reasons that makes Gann's work stand out and also widely followed is the fact that for the most part, Gann's methods of analyzing the markets were nearly accurate, something which most technical indicators would only dream to achieve. It is perhaps for this reason, among other things that makes Gann's trading methods much sought after. Whether the information is imparted and if the correct methods are learned, is a different matter unto itself.

Among the many trading methods known to Gann, the square of nine is quite popular.

What is the Gann Square?

Squares, circles and triangles are three most common geometric shapes that form the basis for most of Gann's works on analyzing the financial markets. Gann's wheels and squares are some of the most common applications and form the cornerstone of Gann's work. However, the wheels and squares hold a lot more significance and offers more than just scratching the surface, which is the case most of the times. Square of nine, Square of 144 and the Hexagon are some of the many works from Gann that are popular.

How to construct the Gann square

The Square of nine or Gann Square or Master Chart is also known as the square root calculator and finds it basis from Gann's methods which is squaring price and time. The square of 9 is a spiral of numbers with the initial value "1" starting off at the center. Starting from this central value, the number is increased as we move in a spiral form and in a clockwise direction. According some experts, each cell in Gann’s square of nine represents a point of vibration

The Gann square of nine gets its name because if you look at the above chart again, the number 9 represents the completion of the first square. It is also known as a 9x9 chart, or simple square of 9.

The numbers within the Gann square also follow a certain harmonic pattern in their occurrence. For example, when you take a number, such as 54 from the above square, the value to the next of it (to the right), 29, is derived as follows:

Square root of the number and subtract 2, and re-square the result.

Ex: 54 is the original number

Square root of 54 = 7.348469

7.348469-2 = 5.438469

(5.438469)² = 29 rounded off

To determine the value to the left, instead of subtracting 2, the number is added. So, we simply add +2 to the square root of 54 which is 7.348469, bringing the value of 9.348469 raised to the power of two to 87.393 or simply 87.

To see this result, simply continue adding the numbers from 81 on the above square to build a new square and you will notice that 87 sits to the left of 54, as mentioned above.

How does the Gann Square work?

The Gann square of nine is simply a tool which calculates time and price besides calculating the square root of numbers including the mid points. When starting out at a specific level, the Gann square of nine helps to look for time and price alignments which is used to forecast prices.

Typically, the time alignment is used for swing trading or for longer periods and is usually discarded when using Gann square of nine for intraday trading where only the support and resistance levels are of importance. Of course, there are many different ways traders interpret the square of nine chart with some going on to be quite complex equations for day trading.

In the Gann Square of nine, the key numbers of importance are as follows:

• Numbers representing 0 or 360 degrees: 2, 11, 28, 53....
• Numbers representing 45 degrees: 3, 13, 31, 57, 91...
• Numbers representing 90 degrees: 4, 15, 34, 61, 96...
• Numbers representing 180 degrees: 6, 19, 40, 69...

The next sets of important numbers are the ones that fall within the Cardinal Cross and the Ordinal Cross. The next picture below shows the Cardinal Cross, represented in the blue line horizontal and vertical lines while the Ordinal cross numbers are the ones represented in yellow cells set at an angle. The numbers that fall in the cells represented by the Cardinal and the ordinal cross are said to be important support and resistance levels with the numbers in the ordinal cross coming in at the second in terms of importance.

In other words, the numbers falling within the cardinal cross are strong resistance and support levels to trade off from, while the numbers falling within the ordinal cross are strong but can be breached nonetheless.

Gann Square - Cardinal and Ordinal Cross

From the above chart, one the most important numbers as we know it occurs every 45 degrees on the Gann square of nine chart. The degrees are said to be associated with time, which is irrelevant especially when you are using the Gann square of nine chart for day trading. The above standard chart is also known as a 1x1 chart. As an example, if price made a high of 54 on the day, then if price retreats, the next support is seen at 29, as it is the next number that is closest to the number across to the square of nine.

Besides the Gann square of nine, drawing a circle connecting the four corners of the squares brings the concept of angles into perspective. The angles, measured by degrees can point to potential support and resistance levels when price is said to be moving within an angle.

The chart below shows the Gann square of nine with the circle plotted around it.

Gann Square of nine with the circle, introducing angles and degrees

There are many online Gann square of nine calculators that claim to the rest of the hard work. But to put it in a very simple form, to use the Gann chart, simply replace the starting number 1 with a number of your choice and the step value as well (for example in a 1x1 chart, the starting number is 1 which then moves in increments of 1 thereafter). The subsequent numbers that crop up in the ordinal and cardinal number cells are key resistance and support levels.

Based off this information, traders can look to either buying or selling into the nearest support or resistance level. Note that at this point in time, the Gann chart has only revealed the support and resistance levels because time factor hasn’t been added into the equation just as yet which takes it to the next level in forecasting prices and more suited for swing trading and for the long term.

Other ways of trading based off the Gann Square of nine involves, looking at the dates as well to forecast potential price levels and moving the square of nine across the circle at certain angles. However, traders should bear in mind that Gann’s Square of nine is not always 100% accurate and there are times when the Square of nine analyses has often resulted in losing trades as well.

Besides looking at the date factor, Gann’s square of nine also factors in planetary movements and the degree of price movement based on the circle, among other things. When using Gann’s trading methods, the most important factor to bear in mind is that Gann used his methods in forecasting prices. There is a big difference between forecasting prices and trading prices, which traders need to be careful about. For example, one can forecast that the Emini S&P500 will rise to 2100 within a certain period of time. What the forecasting won’t tell you is whether the move to 2100 will be straight, or if price will fall by a significant number of points before rising to 2100 and so on. These might seem insignificant when it comes to forecasting, but they can be very things that can define a successful or a bad trade from a trading perspective.

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The new High new Low ratio is a technical indicator that is very simple. It measures the number of securities trading on the New York Stock Exchange (NYSE) which have hit a 52-week high and counts the number of securities that have hit a 52-week low. The new high and low indicator counts all securities listed, including stocks, preferred stocks, closed end funds and ETF's.

Traders and investors have used the new highs and new lows indicator to gauge the market sentiment. Broadly speaking, the higher the number of stocks reaching a new 52-week high, the larger the market advances are which is assumed to occur on a wide range of issues that spurred investors into the bullish mode.

Similarly, when the count of the new high stocks starts to fall but you see that the stock index is still making highs, it indicates that only a few stocks are participating in this rally. Therefore this divergence offers a sign of an impending declining.

From a day trader or a technical trader perspective, the new high and new low indicator or new high/low ratio indicator is akin to using a technical oscillator on the chart and comparing it to price. For example, the RSI, which is based on the price, is a useful indicator to signal divergence in the security.

Under normal circumstances, the prevailing theory is that price and its oscillator (or in the context of this article, the new high/ new low indicator) must converge at all times. So when a security is at a high, the oscillator or the RSI must also confirm this by posting a high, same when the security posts a low, the RSI must also post a low.

A divergence is said to occur when either the security or the oscillator do not conform to each other.

The chart below shows a simple illustration of the convergence and divergence between a security and an indicator. This same principle is applied to the stock markets as well. The only difference here being that, one could use the major stock market index such as the Dow Jones or the S&P500 and compare it to the new high new low indicator to get an idea if the new highs in the index are as a result of broader stock market strength or if the rally to new highs was based on just a few stocks in the market.

While convergence will tell you that the new highs or lows are a result of broader participation, divergence can be a powerful tool as it can point you to potential weakness. When a new 52-week high in a stock index fails to be confirmed by the broader stock market, by means of using the new high new log indicator, it is a warning to investors to be careful when taking on new positions.

Convergence and Divergence Example

What is the new high new low ratio indicator?

The new high new low ratio indicator or NH/NL Ratio for short as explained earlier is a ratio of the number of stocks making a 52-week high and the number of stocks making a 52-week low. This indicator visualizes this phenomenon and can be useful for the stock trader to understand the relationship of the stocks that are making new highs and lows. A higher reading in the NH/NL ratio indicator means that more stocks are participating in the rally.

The calculation, as you might have guessed by now is very simple.

The new highs and new lows indicator is published on a weekly basis at any major financial website. The general rule of thumb is:

• the market is positive when the NH/NL ratio is biased to the upside. Ex: 400 new highs to 45 new lows
• the market is negative when the NH/NL ratio is biased to the downside. Ex: 40 new highs to 350 new lows
• the market is churning or is split if the NH/NL ratio is even. Ex: 400 new highs and 400 new lows

The picture below shows the weekly number of new highs and new lows across the different exchanges, published by Barrons (click here to access).

Barrons’ Weekly new highs and lows indicator (source)

As an example, the above data for the week ending 23^rd February 2017 shows 403 Nasdaq stocks making a new 52-week high against 36 Nasdaq stocks making a 52-week low. The NH/NL ratio in this case happens to be 11.19.

Applying this to the Nasdaq composite index you can see that the ratio if highs and lows coincides with the high in the index, thus implying that the stock markets are rallying on a broad participation of stocks.

Nasdaq Composite index (23-02 Closing)

The new highs and new lows indicator goes by different names, depending on the website, and the charting platform that you use. For example, stockcharts.com a site well known among stock market technical analysis calls the new highs new lows indicator as the High-Low index. The name may be different, but it is the same. The index measures the stocks posting a 52-week high and a 52-week low. The high low index is an advanced version which is a 10-day average of the record high percent.

The record high percent is nothing but dividing the number of stocks making a 52-week high by the sum of all stocks making a 52-week high and a 52-week low.

For example, if you look back at the previous data for Nasdaq, (403 NH and 36 NL), then the record high percent is 403/(403+36) which is 0.917 or 91.7%.

The chart below shows the S&P500 stock chart with the SPX HI-LO indicator shown below. The indicator show the extremes, which when coinciding with the peaks and troughs in the index can be used as a powerful way to pick tops and bottoms.

SPX Stock Chart with the SPX Hi-Low indicator (Source - Stockcharts.com)

Strategies to use the new high new low indicator

The new high new low indicator is primarily used as an indicator to measure the market breadth and to validate the highs or the lows in key benchmark stock indexes. Therefore, in terms of the strategies available, the best use of the new high new low indicator is suited trading the stock index futures or ETF’s.

Here are three ways on how traders can use the new high new low indicator in their trading.

1. Timing the markets

The most obvious strategy that can be applicable to traders, regardless of whether one is a swing trader or a day trader is to look at the new high new low indicator to time the markets. Because the indicator tracks the components of the exchange, it is best used on an index such as the Nasdaq or the S&P500.

By using the new high new low indicator, traders can look to buying into the ETF or a futures contract when the new high new low indicator is above 50. Alongside this confirmation indicator, traders can also look at applying a 10-day moving average to the chart as well as a second confirmation. Finally, looking to the price action itself such as the candlestick pattern or a chart pattern such as bullish flags or pennants can help to bring more validity to the outlook.

The chart below shows the SPX applied with the 10-day simple moving average with the new high new low indicator. In the region marked, you can see that the indicator is above 50, and this is later confirmed by price trading above the 10-day moving average.

Timing the market with the New High New Low Indicator

It is up to the trader from here on as to whether they want to hold their position over a period of time or to book profits if they are trading futures. In this example, the focus is not to confirm whether the market high is validated by large number of stocks making new 52-week highs, but to use the 50-level in the oscillator to see which way the market is biased.

A reading between 50 and 75 is a fairly good indicator that the market sentiment is bullish and thus traders can buy into the rally. The bullish bias is even better when validated by other indicators such as the moving averages.

2. Buying channel breakouts

Channel break outs, or specifically Donchian Channels are a great tool to add to one’s technical analysis arsenal when dealing with breakouts of any kind. Thus, the Donchian channel indicator makes for a great addition that compliments the new high new low indicator. The new high new low indicator can be used to validate the breakouts from the 20-day Donchian Channel high and can be used as simple way to trade the S&P500 index.

The chart below shows the 20-period Donchian Channel applied as an overlay on the chart and the new high new low indicator seen below the chart. The blue arrows shows potential levels where you would have been long.

Donchian Channel with New High New Low Indicator

With the Donchian channel strategy, the trading rules as simple. Buy when price breaks out above the 20-period high and the new high new low indicator is above 90. This value can of course be adjusted to 80 and it up to the trader’s discretion.

Once the new high new low indicator is above 90, in this example and price breaks above the 20-period Donchian channel, you can place a long position and hold until the new high new low indicator dips below 90. The first section shows a long position that was held from around 2180 on November 21 and the position was held until we got an exit trigger at 2240 around December 27, thus giving a neat 40 point move in the market.

Following, the red arrow shows the area where you would have remained on the sidelines as there was no breakout in the Donchian channel at the time the new high new low indicator was above 90 or vice versa. The more recent signal came around 12^th or 13^th of February with a long position at 2310 with the long position still held while the S&P500 is at 2363.81.

3. Divergence and moving average confirmation

The new high new low indicator can also be used as a divergence indicator to spot any discrepancies while also applying as a confirmation for a bullish moving average crossover. The next chart below shows the divergence as the Dow Jones Index falls to make a new low, but the new high new low indicator shows a higher low being formed.  This is later followed up by the bullish moving average crossover and validated by the new high new low indicator above 50 and rising.

New high new low indicator as a bullish confirmation indicator

As you can see from the above, there are many different uses to the new high new low indicator. For traders who prefer to use the technical aspects of day trading, the new high new low indicator can inform the trader about the general market sentiment, thus keeping you on the right side.

The new high new low indicator goes by many different names and is usually not widely available on many charting platforms. Therefore, day traders need to research into the charting platforms where the new high new low indicator is available. In most cases, the data can be calculated manually via the weekly or daily information published from websites such as Barrons.

For all the information the new high new low indicator has to offer, traders should realize that this is applicable when looking at the broader stock markets. Thus, in terms of its uses and application, the new high new low indicator is best used to trade index futures or index ETF’s which offer a better gauge of the stock index and is liquid enough to day trade.

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

What is the Time and Sales Window?

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

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

How to Use the Time and Sales Window

I am a very big believer that there are two truths in trading stocks. One is price and the other is volume. Tape reading involves both; and if used correctly, dramatically increases the odds of your trading working out. It does so due to the fact that your goal with tape reading is to follow the money.

While some professional traders may not like to admit it, trading stocks is an odds game. Your job as a trader is to put trades on with the highest odds of winning. Trading with the tape requires trading with patience. You cannot go out and buy or short a stock because you see the tape speeding up a bit. You need to be aware of support and resistance levels and also combine the message of the tape with price pattern formations.

Tape reading can be very fast and confusing at times and requires quite a bit of practice in order to get used to understanding the true meaning behind what you are seeing. Remember, every stock is a different story and tends to trade differently. It is wise to review the way in which the "tape" trades for a couple of minutes before entering a trade. Reading the tape requires you to train your eyes to scan for changes in character. I want to discuss a few of these key changes that you should take note of:

Size of Orders

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

Order Speed

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

Order Condition

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

Speaking from Experience...

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

Which stocks are best to trade?

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

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

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

Tape Reading with Level 2

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

Exiting a trade

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

Bid/Ask Spread at Key Levels

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

Extremely High Volume Stocks

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

Make price prove the point

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

Don't let your ego get in your way

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

Focus

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

Conclusion

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

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Most day traders have a love or hate relationship with tick charts. Meaning, either you cannot trade without the tick data, or you absolutely despise the use of tick data as it can complicate making trading decisions. You would think there are some gray areas, but not really.

You see, tick charts display a certain number of trades before printing a new bar chart. In a way, you can find the price and volume of every print from the historical tick data of a stock or trading instrument. Hence, unlike other charts which are based on time, tick charts are solely based on trading activity.

Day traders who favor tick trading find it easier to just look at the tick by tick data in order to make quick trading decisions. If you do not have the time to wait for a 5-minute bar to close and need to make your decision to buy or sell, the stock tick data can be a great help. This is because, you would find a wealth of information about the details of the trading activity from the stock tick data or futures tick data.

However, if your trading strategy is purely based on technical indicators, you would find that tick data can create complications. In this discussion, we will explain to you how tick data can be a real nightmare for day traders, and why.

#1 - There are Too Many Time Frame Options

Look, if you are watching a 5-minute chart, you can be pretty sure that by the end of every five minutes, a new bar or candlestick will form on your day trading chart. But, guess what, you really cannot predict how many ticks there would be during that same 5-minute time frame.

Before April 2001, there was a standard measurement of a “tick.” Whenever the price of a stock moved 1/16^th of a dollar, you could call it a tick. Therefore, if you were watching tick charts, price moved $0.0625 at a time.

But, as major stock exchanges around the world moved to decimal pricing, that definition of a tick became obsolete. Now, a 5-minute chart can contain as many ticks as possible. This is because tick charts are formed based on the number of ticks, not time.

Comparing EDGE vs. MSFT Tick 1-Minute Chart

If you are fond of trading highly popular stocks likes Apple (AAPL) or Google (GOOG), you may find 10,000 ticks in a 5-minute chart during earnings calls. On the contrary, unpopular penny stocks may not have a single transaction during lunch hours, and you may have to wait a long time for a single tick bar to appear!

Also, there is no standard time frame to watch the tick data. A lot of brokers show tick data on the 1-minute chart. But, as you do not know which stock would have how many ticks during a single time frame, it is really not possible to compare the tick charts like bars with fixed time frames.

You may say that tick charts based on the number of ticks is a good way to go about it. In fact, you would find that a lot of day traders often watch tick charts based on Fibonacci numbers. But, how would you decide on which tick charts to watch?

Sure, the most popular one is 233 ticks, but that’s just another example of a self-filling prophecy, isn’t it? There are simply too many possibilities as you can use any number of tick count to formulate your tick chart.

#2 - The Action Can be Too Fast (or Too Slow!)

As we just discussed that there are hardly any standardized time frame to watch the tick charts and the ticks can come 10,000 per second or absolutely zero – there are no hard and fast rules in the tick universe.

So, during important news releases or market opening, the tick charts can move really, really fast. There are enthusiastic people in this world who have invested millions in high frequency trading and mainframe computers to interpret the tick data.

But, as a human being, you would often find the speed of the tick charts to be overwhelmingly fast to make any sense of it.

Most Unpopular Stocks Have a Very Low Number of Transactions on Traditional Time Frames

On the other hand, if you are trading unpopular stocks, you may have to wait a long time to find a complete bar on the tick charts that contains the number of ticks you have selected, which would not help you to make any trading decisions during slow moving market times.

#3 - What Good is Downloading Tick Data if You Cannot Use It?

Many beginner traders think that keeping an eye on the tick charts can give them an edge in day trading. Guess what? If you cannot interpret the real-time data, because at times, it is too fast, what good would it do for improving your trading results?

We are not saying that tick data is worthless, just that for day traders who make trading decisions based on technical analysis, it can often do more harm than good.

Instead of religiously watching tick charts, simply watching the volume indicator can give you the real-time information you need. Moreover, since volume can go up or down relative to the time frame you are watching, you can actually use it to make an informed trading decision.

#4 - Tick Data is Expensive - Don't Kid Yourself

If your broker offers free tick data, you are in luck. But, before you schedule an hour to watch it tonight, let us be the bearer of bad news. Nothing in this world is free and the free lunches you get in life often cost you more some other way.

The free tick data provided by many brokers often contains errors, if not missing parts that can prove costly if you use it to formulate your trading strategy. On the other hand, quality tick data can be really expensive.

Tick Data Costs

If you do a quick Google search, you would find that it costs around $3,000 to buy historical tick data for the NASDAQ 100 package that contains only 169 symbols. The complete package containing S&P 500, ETF, and DJA, etc. can even put a $100,000 hole in your wallet. Trust us, you would be much better off buying that Tesla Model S you always wanted with that money.

#5 - Technical Indicators Do Not Respond the Same Way

Technical Indicators Stop Working

Do you know that almost all popular technical analysis indicators are based on the concept of Open, High, Low, and Close or OHLC bars? You would also find it interesting that unless you are looking at a fixed time frame, the OHLC data would not make any sense at all.

For example, the opening price of a 1 minute chart and 5 minute chart would be different, right? What if there were not open or closing price of the bar for the last 2 bars? How do you think your moving average indicator would behave in a situation like that? If you are using tick charts, that’s a real issue.

Regardless of how advanced technology is used to measure tick data, the most popular indicators for day trading would never work the same way on tick charts as these work on a bar or candlestick based chart that shows the OHLC price data on standard time frames like 5-minute or 15-minute charts.

You may want to argue that tick trading has some application in “naked” technical analysis. However, if you do not have a standard time frame to figure out if the price “closed” above the resistance, how would really know if the resistance was broken? Moreover, it will not make much sense if other traders were not seeing that same breakout, as the whole concept of momentum trading depends on being in sync with the market.

Conclusion

High frequency trading that utilizes super-fast computers to analyze real-time data has some practical application for using tick data. However, as a day trader working from your basement on a Core i5 workstation with a fiber optic connection, watching tick charts will hardly help to improve your trading. Instead, it will complicate things to a certain extent.

Moreover, the combined cost of buying quality tick data from reputed sources, the additional investment it requires to buy adequate computer hardware that can handle tick data, and the time commitment you would require to put everything together may not offer the return you would initially expect.

If you mostly trade based on popular technical indicators along with some basic chart patterns, you are much better off back testing solutions that offer a comprehensive package for replaying various standard time frames instead of analyzing expensive tick data in real-time.

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Level II Quotes

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

Level II Window Structure

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

Security Information

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

Stock Ticker

Bid Ask Window

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

Bid Ask Spread

Depth Chart

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

Depth Chart

Bid Ask Orders

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

Bid Ask Window

Example of Level II Window

Level II Quotes

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When you are just starting to take baby steps in trading, usually the first thing you are concerned about is what are the best day trading indicators and chart configuration you should use. Wouldn’t you agree?

Well, you should modify the question slightly and try to find what day trading indicators are best for you.

As you would probably agree that we are all different, have a different psychological make up, and have different expectations from day trading. Because of that diversity, we all should try to find the best indicators for day trading that suit our own personality and how we trade, instead of simply mimicking another successful day traders and their trading set ups. Otherwise, we will end up losing money in the market faster than how the New York Mets lost their games in 1962!

Let’s have a quick discussion about how you can find the best indicators for day trading and pick a day trading charting software that will help make your life a bit easier during the trading day.

In order to build or develop your charts for technical analysis, you need to mainly decide about three components: (1) the right time frame, (2) the right on-chart indicators, and (3) a set of the right off-chart indicators.

Picking the Right Chart Time Frame

Do you think all indicators are created equal? No, but more importantly, not all indicators work the same way on all time frames. For example, lagging indicators like moving averages work best when there is less volatility. You would benefit highly from using a long period moving average on a daily chart compared to using the same configuration in a 5-minute chart of your favorite day trading chart software.

However, we do not want to impose any hard rules and convey the wrong message that there is any best time frame to day trade. You may have a higher patience threshold and prefer to use 15-minute charts, and I might have a lower patience threshold and prefer the 5-minute time frame.

While there are no hard-and-fast rules about which time frame you should use in day trading, you should consider a few things to make up your mind about picking the best time frame for yourself.

The first you should make up your mind when starting day trading is this: how much time would you devote to trading during the day? If you have a day job, you probably do not have much time to begin with and would likely spend only a few hours in front of the screen. On the other hand, if you are self-employed or run a small business, you will probably have a lot of free time to trade during the day.

So, the rule of thumb is that you should use a lower time frame when you would spend less time day trading. Similarly, you should use a higher time frame when you would be keeping an eye on the market throughout the trading day.

This is because when you are spending only a few hours in day trading, a 15-minute chart will only generate a few handfuls of bars and your day trading charting software, with all its advanced technical indicators, will have a hard time generating a proper signal with the limited data.

Figure 1: Comparison of a Bullish Move of Apple Inc. on 5-Minute and 15-Minute Chart Time Frame

Instead, if you use a smaller time frame like the 5-minute chart, your day trading charting software will have the opportunity to analyze a lot of price data from enough bars and would be able to tell you which way the market is moving during that short period of time.

Moreover, when you are trading 8 hours a day and looking at lower time frames, you will have to analyze a lot of potential trading setups. As the number of trades goes up, as a human being, wouldn’t you feel tired of making so many decisions in a single day? The more you would trade, it is more likely that you will end up making more mistakes and give back the profits to the market.

If you are still not convinced, let me give you another reason to stick to the rule of thumb we just discussed. Your broker makes their profit by charging you commissions and from spreads. If you make 100 trades during the day and only end up making a few cents of profits on each of them, you are effectively paying a fortune to  your broker in fees.

Do not end up working for your broker, take the time to analyze a trade properly, keep the number of trades low, and be a day trader – not  a scalper.

Using On-Chart Indicators for Technical Analysis

If you add a ton of different indicators, it may look terrific or ugly, depending on the colors – of course, but you will probably find it difficult to interpret all the different data at once. You do know that all technical indicators are based on calculating the price data, right?

Hence, taking a “less is more” approach would not only help you declutter your chart, but also make it much easier for you to interpret the on-chart indicators on your chart.

Figure 2: Apple Inc. 5-Minute Chart with Volume, 10 Period SMA, and ATR Indicators

Personally, I strongly recommend that you keep the Volume indicator on your chart at all times. The volume is a secular on-chart indicator, it does not tell you which way the price would go. But, it will tell you if there are ample transactions in the market and whether the bigger players are involved when the price approaches a key breakout level.

In addition to the Volume indicator, I always keep the 10-period simple moving average (SMA) indicator on the chart. The 10-period moving average is one of the most popular indicators among day traders. It is fast enough to give an early indication and direction of a significant price move, but not too slow like the 20-period moving average that I would leave a large chunk of the profits on the table when the trend ends, or worse, reverses.

Besides these two EMAs, you would also find the Average True Range (ATR) indicator sitting at the bottom of my day trading charts. Because the ATR value gives you the accurate representation of the volatility based on the actual price of the stock and forces you to assess each stock on a case-by-case basis. Would you really think the volatility of Microsoft and Tesla would be the same if they had the same ATR reading?

You can also use a few other derivative indicators to know about the important support & resistance levels. For example, I have a plug-in which automatically plots the pivot points used by floor traders, and I draw the Fibonacci levels of important price swings manually.

Using Off-Chart Indicators in Day Trading

While you would find the on-chart indicators to be essential for technical analysis, at the end of the day, charts and indicators are just sugar coated versions of the order flows that makes up the overall supply & demand in the market.

If you were a retailer, selling fruits, would you prefer to buy your stock from the wholesalers or the farmers themselves? Where would you get the best price? Of course, from the farmers.

In this analogy, if you would get the wholesale information about the market from technical indicators, you would get the best data from the Level II quotes. These quotes are the actual pending orders that other traders have placed with their brokers.

Figure 3: Apple Inc. Level II Data

When traders place market orders to match these pending orders, these get filled. So, if you know that there are a lot of large pending buy orders below the current market price compared to sell orders, you can easily figure it out that if the support levels on your chart would hold the price or it would break below! Interesting right? You can explore about Level II here.

Figure 4: Apple Inc. Time & Sales Window on TradingSim.com

When it comes to day trading, I also heavily depend on another off-chart indicator – the Time & Sales data. Tradingsim offers this data in the “Time & Sales Window,” which represents the traditional “Tape.” By combining the volume and tape data, you easily get a “feel” of the market. Watching the detailed information regarding the order flow on the “Time and Sales Window” and depth of the pending orders in the Level II window of a particular stock can really take your day trading skills to a new level.

Conclusion

Success in day trading often boils down to the personality of the trader compared to how advanced the trading system he or she is using. That’s why, we always suggest that you keep things as simple as possible and focus on a few important indicators.

If you want, you can use a multi-screen trading setup and keep Tick Data, the spread between the S&P futures and the cash market, support & resistance, and Fibonacci levels of major stock indices like the S&P 500, etc. in a separate monitor.

However, always remember that the more information you have on the screen, the more time and energy it would require to analyze and process them. If you follow the advice given here and successfully match the right time frame, on-chart technical indicators, and tie the system with off-chart indicators, you would have a much better chance of becoming a successful day trader.

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Trade Volume Index Definition

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

Who is using the Trade Volume Index

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

How to use the Trade Volume Index

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

How to Calculate the TVI

The trade volume index is calculated by using the following formula

MTV = Minimum Tick Value

Change = Price minus the extreme price since direction changed

If Change is greater than MTV, then Direction = Accumulate

If Change is less than MTV, then Direction = Distribute

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

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

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

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

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0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377…do these numbers look familiar to you? Not really, right?

If not, then you definitely need to read the following material. These numbers are the root of one of the most important techniques for determining psychological levels in life and in trading.

Behold the mighty Fibonacci ratios!

Origin of the Fibonacci Sequence

Hundreds of years ago, an Italian mathematician named Fibonacci described a very important correlation between numbers and nature. He introduced an interesting number sequence starting from zero and one (0, 1).

Have a look below, as we build a Fibonacci sequence:

0, 1

Now we perform the following calculation, where we add to the last number to the previous number in the sequence:

0 + 1 = 1

The result we get here (one) is the next number in the sequence. Thus, we now have the following:

0, 1, 1

Now we add the last number in the sequence to the previous number as shown below:

1 + 1 = 2

Then we add 2 to our sequence:

0, 1, 1, 2

We repeat the process of adding the last number in the sequence to the previous number:

1 + 2 = 3

…and the next one:

0, 1, 1, 2, 3

……and the next one:

0, 1, 1, 2, 3, 5

……….and the next one:

0, 1, 1, 2, 3, 5, 8

………….and the next one:

0, 1, 1, 2, 3, 5, 8, 13

We repeat this process as many times as we want!

Now you know how I derived the numbers in the beginning of the article - 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377.

Key Fibonacci Ratios

But what is so interesting about these numbers? As you probably guess, the fun part begins now!

So, Fibonacci discovered the following: every number of this infinite sequence is approximately 61.8% of the next number in the sequence. If you do not believe me, let’s dive into the math for ourselves!

55 / 89 = 0.6179775280898876 = 61.8%

Wow! Let’s double check!

233 / 377 = 0.6180371352785146 = 61.8%

Do you believe me now? No? Ok then:

144 / 233 = 0.6180257510729614 = 61.8%

I think this is persuasive enough!

However, this is not the only thing, which Fibonacci introduced. He also found out that every number in this sequence is approximately 38.2% of the number after the next one in the sequence:

13 / 34 = 0.3823529411764706 = 38.2%

21 / 55 = 0.3818181818181818 = 38.2%

55 / 144 = 0.3819444444444444 = 38.2%

144 / 377 = 0.3819628647214854 = 38.2%

And also, we have another ratio! Every number in the Fibonacci sequence is 23.6% of the number after the next two numbers in the sequence:

55 / 233 = 0.2360515021459227 = 23.6%

Note that these percentages can be retrieved from each number pair, which is part of the Fibonacci sequence, continuing to eternity.

Fibonacci Ratios Everywhere

So, this is how the famous 61.8%, 38.2% and 23.6% Fibonacci levels appear. Later, traders added another level as an addition to the Fibonacci levels.

This is the 76.4% level which is 100 – 23.6. But, what is so important about these percentages?  The truth is that these ratios are all over the place in nature. Look at this shell for example:

Fibonacci Sea Shell

The volume of each part of the shell matches exactly the Fibonacci numbers sequence. Thus, each part of this shell is 61.8% of the next. It works the same way with this aloe flower:

Aloe Flower

The relationship here is the same as with the shell. If we separate the aloe flower into even particles, following the natural curve of the flower, we will get the same 61.8% result.

This ratio is not only found in animals and flowers. This ratio is literally everywhere around us. It is in the whirlpool in the sink, in the tornados when looked at through satellite in space or in a water spiral.

The Fibonacci ratio is constantly right in front of us and we are subliminally used to it. Thus, the human eye considers objects based on the Fibonacci ratio as beautiful and attractive.

It works the same way even with human faces! Faces with parameters (eyes to mouth distance, eyes to nose distance, ears to eyes distance) closer to 61.8% are beautiful and attractive to the human eye.

In this manner, big corporations like Apple or Toyota have built their logos based on the Fibonacci ratio. After all, we should not forget that these are two of the most attractive and engaging logos in the world.

These ratios can also be found in human behavior and psychology.

Example: Scientists say that the average person needs a bit more than 9 hours of sleep in order to be energetic and to lead a healthy life!

So, let’s take 9 hours and 10 minutes as an average time, which humans spend sleeping every day. This means that in the other 14 hours and 50 minutes we are awake. 14h:50m = 14.83 expressed as a decimal.

Let’s now see what percentage of the day we are awake:

14.83 / 24 = 0.6179166666666667 = 61.8%

Indeed!

Another example of Fibonacci ratios in people’s behavior is when we go out clubbing with cash in our pocket. It is proven that people get depressed when they spend more than 61.8% of what they have in their wallet.

You will say “But how does all of this apply to trading?” Relax! We are almost there!

It is the same in trading!

Fibonacci Ratios in Trading

Once an impulsive move terminates, the price of the equity is expected to decrease 38.2% and eventually 61.8%. Since it is in people’s nature to “freak out” when stocks retrace, investors tend to change their attitude when the price moves 38.2% or 61.8% in the opposite direction.

Thus, Fibonacci Retracement is a common practice to seek support and resistance in case of trend reversal. Every equity trader always double-checks his decisions with the Fibonacci trading system in order to confirm psychological levels.

Fibonacci ratios, when applied to trading stocks, correlate two trends; let's refer to them as primary and secondary.  The primary trend refers to a trending move in one direction while the secondary trend will refer to counter trend moves in the opposite direction.  The three most common fibonacci retracement levels are 38.2%, 50%, and 61.8% of the primary trend and most basic stock charting applications will use these as standard levels.  These fibonacci retracement levels act almost as magnets once the counter trend rally takes place.  These are very common, however, there are a few other fibonacci levels that can provide resistance.  These are the 75%, 78.6%, 87.5%, and 88.7% retracement levels.  The common rule of thumb is that when the 50% retracement level is taken out, the four levels I just mentioned become magnets to attract price.  Price action must be analyzed at those levels to understand if the countertrend move will cease or whether it will continue to fully retrace the primary move.

Fibonacci retracement levels are used by many floor traders and therefore become very relevant to your fibonacci trading activities.  These levels are so widely used now by traders, including systematic trading, that they almost become a self-fulfilling prophecy.   Some advanced traders will take it a step further and add fibonacci arcs and fibonacci fans to their trading arsenal, in search of an edge.

Defining the Primary Trend

Let's start with the characteristics of the primary trend of which we would want to play the countertrend.  I found that fibonacci retracement levels are most accurate after the primary trend has been a sharp move in price accompanied by heavy volume at the end of that move.  These types of moves typically exist in the story stocks of the day or the appear on the list of highest percentage gainers or losers list which complements my trading style as these are the only stocks that I will trade.

I am asked many times how to define the starting and ending points in order to calculate the length of the primary trend.  I see many traders make the mistake of using the highest point and lowest point of a trending move to define the starting and ending point of the primary trend.  While this may work in some cases, it is best to look for double tops or double bottoms when locating your starting and ending points.  This may or may not coincide with the highs or lows of the move.

How to Use Fibonacci Levels

I do not use fibonacci levels as a primary trading technique, however, I found that it greatly improves my odds of generating a winning trade when fibonacci retracement levels start correlating with price objectives using other patterns, such as candlestick charting formations for example.  I use fibonacci levels in two ways:

1)  After identifying the primary trend, use price reversal pattern recognition (through candlesticks or any other trading technique that you employ) to coincide with a fibonacci retracement level to confirm that the countertrend move has ceased.  I then look for the stock to test the recent lows and double bottom or break through that level.  That is where I employ the usage of tape reading to determine whether I should play the double top/bottom or whether I should play a breakout in the direction of the primary trend.

2)  Many times, a stock will spike down on high volume and that will signal capitulation and put a floor in the market.  Usually, an automatic rally will ensue and fail when the dip buyers lose their buying pressure.  Oddly enough, this coincides with fibonacci retracement levels (usually 38.2% or 50%).  Once that rally kicks in, a retest of the recent lows will be attempted and a trading range can be created between the lows that were put in with spike volume and the highs of the automatic rally.  This trading range carries on for a bit of time before a breakout up through the range occurs.  This breakout can be bought with good tape action and then the tape action must be hawked as well as keeping an eye on fibonacci levels which could act as resistance.  If I see buying pressure fizzling out at one of the key fibonacci levels mentioned above, I get out of the trade immediately.

As you can see, fibonacci trading is a secondary part of my game but a pivotal one.  You can really hit the sweet spot in trading if you can combine a few key trading elements together and design your own trading system where you put the odds in your favor.  The bottom line, you probably shouldn't leave fibonacci retracement levels out of that mix.

Congratulations! You are now familiar with Fibonacci retracement levels!

Yet, that’s not all folks! Let’s now go through some other tools which include Fibonacci trading techniques.

Fibonacci Speed Resistance Arcs

Fibonacci Arcs are used to analyze the speed and strength of reversals or corrective movements. In order to install arcs on your chart you should first discover a trend.

Then you measure the bottom and the top of the trend with the arcs tool. The arcs appear as half circles under your trend, which are the levels of the arcs distance from the top of the trend with 23.6%, 38.2%, 50.0%, and 61.8% respectively.

Each of the Fibonacci arcs is a psychological level where the price might find support or resistance.

Look at the image below, which shows Fibonacci arcs in action:

This is the 30-minute chart of Apple for the period Oct 26 – Nov 3, 2015.

I have placed Fibonacci arcs on a bullish trend of Apple. The arc we are interested in is portrays 38.2% distance from the highest point of the trend.

As you see, when the price starts a reversal, it goes all the way to the 38.2% arc, where it finds support. This is the moment where we should go long.

I recommend placing a stop right below the bottom created on the arc in case the price does not break the highest point of the trend.  As you see, Apple starts an increase with a strong hesitation around the trend’s high.

Then the price breaks in a bullish direction and we enjoy a winning long position. This trade had us in a long position during a price increase of $3.19 per share.

Fibonacci Time Zones

Fibonacci time zones tool is an interesting instrument, which refers not to price movement, but to time volume. In other words, the time zones based on Fibonacci suggest when a price movement could occur. The tool does this by underlining specific time frames based on Fibonacci levels. The example below will show you how the Fibonacci time zones work:

This is the 60-minute chart of Apple for the period Jul 22 – Aug 10, 2015. The trend we have indicated is the place where we stretch the Fibonacci time zones. This is actually our zero period.

Then the other periods are automatically adjusted. Notice that in this case, Apple’s price undertakes a move based on the Fibonacci numbers (0, 1, 2, 3, 5, 8) expressed in time frames.

Do you remember when we said that Fibonacci ratios also refer to human psychology? Exactly! This also applies to time.

When investors hold a stock for a “Fibonacci” period of time, they tend to change their attitude after this period elapses.

Two Simple Fibonacci Trading Strategies

Next we are going to cover a few Fibonacci trading strategies you can incorporate into your existing trading methodologies.  This is meant to be a fun process, so use what makes sense for your investment approach.

Fibonacci Retracement + MACD

This Fibonacci trading strategy includes the assistance of the well-known MACD. Here we will try to match the moments when the price interacts with important Fibonacci levels in conjunction with MACD crosses.

When we discover this correlation between Fibonacci retracement and MACD, we open a position in the respective direction.

We hold the stock until we receive a contrary crossover from the MACD. The image below will give you a clearer picture of how this Fibonacci strategy works:

Fibonacci MACD

This is the 60-minute chart of Yahoo for the period Sep 25 – Nov 3, 2015. The indicated trend is the place where we adjust our Fibonacci retracement.

The two green circles on the chart highlight the moments when the price bounces from the 23.6% and 38.2% Fibonacci levels.

At the same time, the green circles on the MACD show the confirmation we need in these exact moments.

Thus, we go long every time we match a price bounce with a bullish MACD crossover.

The red circles show the close signals we receive from the MACD.

We open two long positions with Yahoo and we generate a profit of $5.12 per share. This is definitely an attractive gain for a period of about 10 trading days.

Fibonacci Retracement + Stochastic Oscillator + Bill Williams Alligator

In this Fibonacci trading system, we will try to match bounces of the price with overbought/oversold signals of the stochastic. When we get these two signals, we will open positions.

If the price starts trending in our favor, we stay in the market as long as the alligator is “eating” and its lines are far from each other. When the alligator lines overlap, the alligator falls asleep and we exit our position. The next image will show you this Fibonacci trading strategy:

Fibonacci Alligator

This is the 30-minute chart of TD Bank for the period Sep 29 – Oct 14, 2015. As you see, we place our Fibonacci retracement levels on the existing trend on the left side of the image.

The price drops to the 61.8% Fibonacci level and starts hesitating in the green circle. Meanwhile, the stochastic gives an oversold signal as shown in the other green circle.

This is exactly what we need when the price hits 61.8% and we go long! A few hours later, the price starts moving in our favor. At the same time, the alligator begins eating!

Isn’t that lovely?

We hold our position until the alligator stops eating. This happens in the red circle on the chart and we exit our long position. This trade brought us a total profit of $2.22 per share.

Conclusion

• The Fibonacci sequence starts from 0; 1; and every number thereafter is built by the sum of the previous two.
• Every number in the Fibonacci sequence is 61.8% of the next number.
• Every number in the Fibonacci sequence is 38.2% of the number after the next in the sequence.
• Every number in the Fibonacci sequence is 23.6% of the number after the next two numbers in the sequence.
• Additional level on the Fibonacci tools can be found at 76.4%, which is simply 100 -23.6.
• Fibonacci levels are critical in equity trading, because they represent a trader’s behavior and psychological reaction to price changes.
• The most common Fibonacci trading instrument is the Fibonacci retracement, which is a crucial part of the equity’s technical analysis.
• Other Fibonacci trading tools are the Fibonacci speed resistance arcs and Fibonacci time zones
• Successful Fibonacci trading strategies are:
• Fibonacci Retracement + MACD
• Fibonacci Retracement + Stochastic + Alligator
• Fibonacci ratios are the highest form of understanding trading psychology in equity markets!

Photo Credit

Aloe Flower
Shell 

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Slow Stochastic Definition

The slow stochastic indicator is a price oscillator that compares a security's closing price over "n" range. The most commonly used range for the slow stochastic indicator is 14. The slow stochastic formula is calculated as follows:

Slow Stochastic Formula

To calculate the slow stochastic, replace "n" with the range your are monitoring. If you plan on using 14, you will want to find the highest and lowest values over the last 14 trading bars. The slow stochastic can be calculated on any time frame.

While I have provided the equation for calculating the slow stochastics so you can see "under the hood", I strongly advise you to just use the indicator as provided by your trading platform.  Please do not pop out excel and start cranking through slow stochastics calculations using raw market data.

Misconceptions of Slow Stochastics

Divergence in Slow Stochastics and Price Trend

Traders will often cite when a stock makes a higher high, but the stochastics does not exceed its previous swing high, that the trend is in jeopardy. This couldn't be the furthest thing from the truth. The slow stochastics indicator ranges from 0 - 100. So, as a stock rallies, how can the stochastics continue to make higher highs if it hits 98.85? Unlike price which has no boundaries, the slow stochastics is an oscillator, so it will never truly mimic a security's price action. All that matters is that the stochastics continues in the direction of the primary trend.

Oversold and Overbought Levels

Traders will often exit long trades when the slow stochastics crosses over 80 or will buy when the slow stochastics crosses under 20. The problem with this trading methodology is that if a stock is over 80, it should not be looked upon as overbought, but rather as trending strongly. Also, if the slow stochastic is below 20, this is a sign of weakness and without any other form of support present, the stock will likely continue lower.

How to trade the slow stochastics profitably

Below are 4 trading strategies you can use when trading the slow stochastics.  The strategies increase in complexity as we progress through each example.  Please approach each strategy with an open mind as this will challenge the conventional thinking of how to use the slow stochastics indicator.

Strategy #1 - Identify stochastics with smooth slopes

Stochastics that have smooth slopes, which move from overbought to oversold implies that the move down was sharp and without much reaction, thus strengthening the odds of a counter move up.

Slow Stochastics Buy

While this is the simplest of slow stochastics strategies, it has its flaws.  For starters, sharp moves up or down can start consolidation patterns prior to continuing the trend.  If you were to simply place buy and sell signals because the of smooth slow stochastic slopes, you are headed down a rough road.

Still not a believer, let's review a few charts.

AMZN Drifting Lower

Weak Slow Stochastics Buy Signal

After you get a few of these under you belt, take my word you will realize that you need more than a slow stochastics move where the fast line never crosses the slow line on the way down.  While this strategy is the simplest, it doesn't mean easy profits.  You will need to step it up a little on the analysis side of the house, if you want to make long sustainable profits.

Strategy #2 - Follow the Sloppy Stochastics

Far to often new traders will buy oversold slow stochastic readings blindly. Remember, the slow stochastic is an oscillator and like any other oscillator, it can trend sideways for an extended period of time.

You will see the slow stochastics just sitting beneath the 20 line and you will say to yourself, this has been going on for too long.  Trust me, you say you won't, but you will.  This is the downside of indicators, it will give the impression that price action has to change course; however, all of us seasoned traders knows the market will do whatever it wants.

Let's walk through a few working examples to get this point across.

Flat Slow Stochastics

Choppy Slow Stochastics

In each of the above charts of Facebook and Apple you can see how the slow stochastics just began to flat line.  Mixed with emotions of needing to jump the market and the need to put on a trade, it's very easy to see how a trader can end up making a poor trading decision.  In both instances, the rally never materialized and in addition to losing money, you are also losing time sitting in the position.

So, where does this leave us?  The simple answer is that you can take a position in the direction of the primary trend.  For example, as you see the slow stochastics in Apple begin to stay under 20, use this as an opportunity to take a short position to ride Apple all the way down.

Going in the direction of the sloppy slow stochastics will feel very strange at first.  This emotion will be the normal  human reaction that states something has to give and things can't keep going lower.  At this exact moment, you need to fight the need to go counter to the trend and realize that the money is in the least path of resistance.

Strategy #2 has a higher difficulty level then trading smooth slopes; however, it still lacks the context of the full technical picture of a security.

Strategy #3 - Combine the Slow Stochastics with Trendlines

As we just mentioned earlier in the article, the slow stochastics can provide a number of false signals.  The best way I have determined to over come this flaw is to combine the slow stochastics with trendlines to identify proper entry and exit points.

Slow Stochastics Buy Signal

The above image is a 5-minute chart of Apple.  You can see how as Apple goes through its corrective move lower, it hits a support trendline twice and bounces higher.  You will also notice the slow stochastics had a number of moves below 20 that either resulted in lower prices or sideways action.  This is why as a trader you cannot blindly buy a stock just because the slow stochastics is under pressure.

If you use the confluence of the stock hitting support in conjuction with a bottoming slow stochastic, then you are likely entering the trade at the right point.  It may look like magic, but it's really not that complicated.

The mechanics of the situation are such that the trend traders are buying as Apple hits support, at the same time the stochastics traders are buying the oversold reading.  The key to this game is buying and selling right before everyone else does.  If you have a way of identifying when multiple players will be taking the same action for various reasons, you my friend are ahead of the curve.,

This same approach for identifying buying opportunities works exactly the same on the sell side.

Slow Stochastics Sell Signal

The next chart is of Google and as you can see the stock was trending higher nicely.  As the stock hit resistance for the third time, Google also had a slow stochastics reading of over 80.  Just as I mentioned earlier about the false buy signals, look at the number of false sell signals.

Beyond missing out on trading profits, allowing the indicator to whipsaw you like this would also rack up pretty hefty trading commissions.

Now, I do not want to leave you with the impression that you can simply buy or sell a stock when (1) it is hitting a trendline and (2) going over 20 or above 80.  Trading is not that simple.  You can however utilize the slow stochastics to validate the health of a trend relative to previous peaks by seeing if the stock was able to make a higher or lower slow stochastics reading.  This way you can size up a recent high relative to its predecessor to determine if its really time to sell or if the stock still has room to go, regardless if a trendline is staring you in the face.

Strategy #4 - Pull the Trigger After the Slow Stochastics Crosses a Certain Threshold

Anyone on the web can figure out after reading the first 3 Google results that traders should be when the slow stochastics crosses above 20 and sell when the slow stochastics crosses below 80.

So, if everyone can read this on the web, why do you think this approach will make you money?

Another approach is to allow the slow stochastics to cross above a certain threshold to confirm that the counter move has in fact begun.  This level could be 50, 61.8, 78.6, etc.  The downside to this approach of course is that the move is likely to have a few points behind it before you enter the trade.  On the flip side, this will prevent you from getting caught in a stock that is flat lining.

OAS Slow Stochastics

To illustrate this example, I will be using 61.8 as the trigger for entering any new long positions.  This is of course a play on the 61.8% fibonacci level found throughout the market.

In the above chart we see that the stock OAS crosses above 61.8 on the slow stochastics which confirms the move up.  From this point, OAS has an ~4 percent up move before finally topping out.

The key with using a higher slow stochastic reading prior to entering a buy signal is to use this method for fading morning gaps down.  The reason this approach works well is it allows for you to validate the initial gap down is weakening and you can take a long position.  If you were to go in the direction of a strong up trend and wait until 61.8 was crossed, you would likely be buying at the peak.

This approach also works well in the late afternoon trading session.  Those that follow the Tradingsim blog know that I personally do not trade in the afternoon; however, strategy #4 was built for late day setups.

Later in the day, the market has less volume and well experience a number of false breakouts relative to the first hour of trading.  To this point, as a day trader, you will need a method for assessing which breakouts or moves are valid.

As always, a real-life example is worth a thousand words.

Slow Stochastics Late Day Breakout

Notice how in the CLF example the stock had an expected retracement after the morning pop.  Once CLF cleared 61.8 the stock went on a nice run up until 2:30 pm.  By waiting on the slow stochastics to confirm the breakout in conjunction with the trendline break,  you are allowing both the price action and technicals to confirm the start of a new uptrend.

In Summary

The slow stochastics is a great indicator for identifying the primary trend.  If you take it a step further and combine some basic technical analysis methods such as trendlines, you will be able to uncover some hidden trading opportunities in the market.

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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.

The post Why Professional Traders Prefer Using the Exponential Moving Average appeared first on - Tradingsim.

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 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

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

Trending Stocks

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 Spike

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

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

Volume

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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.

The post 3 Simple Price Oscillator Trading Strategies appeared first on - Tradingsim.

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.

The post Glossary of Technical Analysis Terms appeared first on - Tradingsim.

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.

Commodity Channel Index Definition

The commodity channel index (CCI) is an oscillator used to identify cyclical trends in a security. It gained its name because it was originally used to analyze commodities. While the CCI will oscillate above and below the zero line, it is more of a momentum indicator, because there is no upward or downward limit on its value. The default period for the CCI indicator is 14 periods, just as the slow stochastics and RSI. Remember, if you choose to use a shorter setting, the number of signals and sensitivity of the indicator will increase.

How to trade using The Commodity Channel Index (CCI)

Traders have now begun to not only use the CCI to trade commodities, but also for stocks as well. A rule of thumb for the commodity channel index is that oversold is - 100 and overbought +100. While traders will look for divergences in the CCI and the price trend, trend line breaks of the CCI is also very popular. The real story about the CCI is not the indicator, but the community that has been developed around the indicator. An independent trader Ken Wood, has created the "CCI University" that teaches detailed methods on how to trade profitably with the CCI.

How to Use the CCI Indicator when Day Trading

Since you now know the basics of the commodity channel index, I want to explore how to use this powerful indicator when day trading.

First of all, you should remember that the CCI indicator is not a good standalone tool. Like any other oscillator, the CCI needs to be combined with an additional trading tool.

In this article, we will combine the CCI indicator with the stochastic RSI.

The first strategy we will cover is a scalping method that will allow you to hit and run for small profits on a 5-minute chart.

CCI Indicator and SRSI

The upper indicator is the commodity channel index and the lower indicator is the stochastic RSI.

Here are the rules of this strategy:

CCI + SRSI Trade Entry

To open a trade based on the CCI + SRSI trading strategy, you will need to receive two matching signals from both indicators. These could be overbought/oversold signals, divergences, or trend breakouts.

Whenever you get a signal in the same direction from each of the indicators you should follow the direction of the respective signal (short or long).

CCI + SRSI Stop Loss

The stop loss rules of our scalp commodity channel index strategy are pretty straightforward.

You can simply use price action techniques to determine the proper location of your stop.

For example, if you are buying, you should look for a bottom located near your entry point. Simply place your stop loss below this point.

On the other hand, if you are shorting the stock, you should look for a top near your entry price. You will then use this high for your protective stop loss.

CCI + SRSI Profit Target

The rules for taking profits with this strategy are even simpler than the stop loss rules.

You should close your trades whenever the CCI or the SRSI gives you a signal in the opposite direction. It may be an ordinary overbought/oversold signal, or it can also be a divergence or a trend breakout on one of the indicators.

Now let’s review these three rules in the below chart:

CCI and SRSI Simple Trading Rules

The first two green circles on the image above show the two matching signals from the CCI and the SRSI.

After the CCI line goes in the overbought area, it then breaks downwards creating the first signal.

At the same time, the lines of the stochastic RSI are also in the overbought area. The second signal comes when the two SRSI lines cross downwards as well.

This is a short signal and we sell the security.

We then place our stop loss order right above the most recent top. This is highlighted with the red line on the image.

The take profit signal comes when one of the indicators give us an opposite signal. This happens when the CCI line enters the oversold area, which is shown by the rightmost green circle.

Commodity Channel Index Trading Strategy

Now we will apply all the rules we discussed above into a complete trading strategy. We will add the CCI and the stochastic RSI on our chart as described in the strategy.

Commodity Channel Index Trading Example

Above is the 5-minute chart of Twitter from June 6, 2016.

The chart depicts five trades based on signals from the CCI and SRSI. The green circles on the two indicators show when each were aligned and we opened a trade.

The red horizontal lines on the chart show where we placed our stop loss orders for each trade.

Now that we have established the ground rules, let’s walk through the five trade examples:

• On the first trade, the price reverses creating a relatively big bearish candle. In this exact moment, the lines of the stochastic RSI perform a bearish crossover and exit the overbought area. The CCI also exits the overbought area. Therefore, we have matching signals with the two indicators and we short Twitter. Our stop loss is located above the upper candlewick which creates the previous top.
  • Observe that the price starts decreasing. The CCI even creates a bearish trend line (blue).
  • Suddenly, the CCI has a slight interruption of the -100.000 area creating an exit signal. At the same time, the SRSI also has a bullish crossover in the oversold area. We need only one signal to exit the trade. However, we get two exit signals at the same time, which simply means “Get out!”, therefore we exit the trade.
• But now we have two bullish signals from the CCI and the SRSI, right? Furthermore, the CCI breaks its blue bearish trend upwards, putting an extra emphasize on the bullish idea. Therefore, we buy Twitter and place a stop loss order below the bottom as shown on the image.
  • The price starts increasing afterwards and breaks its previous top. The two indicators are increasing too and they both enter the overbought area. However, the bearish signal comes from the SRSI, which lines cross downwards.
• Then the two indicators exit the overbought area, creating a new short signal on the chart. Therefore, we sell Twitter and place a stop loss order above the top.
  • The price starts a bearish run afterwards and the two indicators begin dropping. On the way down, the CCI creates a bearish trend line. See that the price breaks the trend in the second green circle on the line. This is the exit signal from our trade and we close the deal.
• Now we have the breakout through the CCI trend as a first bullish signal. Therefore, we are waiting for a signal from the SRSI. It comes when the SRSI enters the oversold area and its lines cross upwards. Meanwhile, the CCI line returns to its already broken bearish trend, it tests it as a support and bounces upwards. This gives additional strength to the bullish CCI signal. Now we go long Twitter and we place a stop loss below the small bearish hammer candle on the chart.
  • The price starts increasing afterwards. Although the indicators turn out to be pretty chaotic during this trade, they manage to inch higher. The CCI then breaks the 100.000 level upwards, creating our exit signal.
• 30 minutes later, the CCI exits the overbought area creating a short signal. At the same time, the stochastic RSI’s lines cross downwards and also exit the overbought area. This is the second short signal on the chart. Therefore, we sell Twitter and we place a stop above the top as shown with the last red line on the image.
  • The price then decreases rapidly and the two indicators follow the same example. Here we get the exit signal only 20 minutes after we enter the trade. The CCI indicator breaks the -100.000 level and enters the oversold area and we close the trade.

The five scalp trades with Twitter generated a profit of about 2% of the invested capital. At the same time, the longest trade took 1 hour and the shortest one took 20 minutes. This is why this trading strategy falls in the category of scalping.

For some of you, 20 minutes is far from scalping, but the key point is the small gains and not necessarily the length of time in each trade.

Let’s now go through another trading example of the SRSI and the CCI indicator settings.

Commodity Channel Index Trading Example 2

We now have the 2-minute chart of AT&T from June 27, 2016. The image illustrates three trading examples based on the CCI indicator trading strategy in combination with the stochastic RSI.

• The first trade appears when the CCI line breaks the overbought area downwards. At the same time, the lines of the stochastic RSI cross downwards in the overbought area. This gives us the second signal we need in order to short AT&T. Therefore, we sell the stock and we place a stop loss above the top created after the decrease as shown on the image.
  • As you see, the price decreases afterwards. We stay in the trade until the CCI indicator enters the oversold area. This is an exit signal according to our trading strategy and we need to close the short trade.
• The second trade comes when the lines of the SRSI indicator cross upwards in the oversold area and one period later the CCI line breaks out of the oversold area. We have matching signals from the two indicators, which gives us a reason to buy AT&T. Therefore, we go long and we place a stop loss order below the bottom created as shown on the image.
  • This is an interesting trade because both indicators give controversial signals. As you see, after we enter the long trade, the stock starts increasing. The jump lasts four periods and then the price begins to drop, as well as the two indicators. They even go back in the oversold area; however, we keep our trade open. After all, in order to close the trade, we need to see one of the indicators going into the overbought area, or to see the price hitting our stop loss order.
  • Although the price decreases, it doesn’t reach the level of our stop. The price then resumes its bullish move. The increase breaks the previous stop created and at the same time the indicators increase. We close the trade with a profit when the CCI line goes into the overbought area.
• 5 periods after we close the second trade, the CCI line breaks the overbought area downwards. At the exact same moment, the stochastic RSI lines crosses downwards. This means we get necessary signals to short AT&T. After we sell AT&T, the price instantly starts decreasing. Less than 20 minutes later the stochastic RSI goes into the oversold area and its lines cross upwards. This gives us an exit signal for our trade and we close the position.

In these three trades, we generated a profit equal to about 1.00% with our CCI scalp trading strategy. The first and the third trade took about 20 minutes each. The second trade took about 40 minutes.

Conclusion

1. The commodity channel index is an oscillator used to identify cyclical trends.
2. The CCI indicator consists of a line which fluctuates above and below a zero line.
3. The indicator creates overbought/oversold signals. However, it is also used to draw trend lines and to discover divergence.
4. The commodity channel indicator is not a good standalone tool.
5. A good instrument to combine the CCI with is the stochastic RSI.
6. The CCI and the SRSI are good for scalping the market. To implement this CCI trading strategy, you should implement the following rules:

• Enter trades when you discover matching signals from the two indicators.
• Place a stop loss below/above the tops/bottoms as a result of the change in price direction.
• Stay in the trade until one of the indicators gives you an opposite signal.

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Tick Volume Definition

Tick volume is measuring every trade whether up or down and the volume that accompanies those trades for a given time period. If you are a day trader or a short term swing trader, tick volume analysis will assist you in sizing up the market on an intraday basis. Some traders also refer to tick volume as on-balance volume.

When analyzing the market at large, traders often focus on pivot points to look for changes or continuation in trends. This is where all the money is made and lost. In order to trade this effectively a trader will want to obtain an edge that will assist them in determining whether a pivot has the strength to hold the current trend. While many traders have access to volume on a chart, the one thing that volume charts do not show you is the volume that takes place at a given price. Would you want to buy a break of the last swing point, if you knew that it was broken on high volume? Well maybe you would, but it does not hurt to know what is going on at this critical level. Tick volume provides traders with this detailed breakdown of the trading activity at a given level. Tick volume is critical for futures traders, because it is used to assess pivot points, since tick volume is not available for the futures markets.

How to Trade Using Tick Volume

• Identify a pivot point
• Analyze tick volume of pivot point
• Compare volume on retest of pivot point
• Analyze price action on retest of pivot point
• Initiate trade based on price and tick volume at pivot point

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