You don’t need a dozen monitors to be a successful day trader.
The five step approach presented herein will help improve your win/loss ratio. Any system worth using, has at its core a strategy that can be repeated. We use this “rules based system” to confirm whether we have an edge or not.
The best traders have a few simple rules and strategies that make all the difference in their trading outcome.
No matter what time frame you use as a reference point, a trader must have a mental process that enables efficient decision making. Once we make an informed decision, we can weigh our probabilities of success, while simultaneously taking our trading from random, to repeatable and consistent.
Step One: The Indices – “A Rising Tide Floats all Boats”
For this exercise, let’s say a trader is interested in starting a swing position in a technology stock. The first thing we should do, is check the Nasdaq Composite and/or the Nasdaq 100 for bullish confirmation, since this index is heavily weighted with technology companies. Ask yourself these questions:
- Where is price relative to the 9/20ema?
- Are the moving averages (SOTEMA) sloping upward, downward or flat?
- Where is MACD? Above or below the zero line? Has it crossed recently and trending?
- Where is RSI? Overbought or oversold?
- Where is stochastic? In the green or red zone?
The index is thought to be bullish, when price is above the 9/20ema. Ultimately, SOTEMA is sloping upward and RSI is trending from oversold (< 30) territory. This setup might also be accompanied by MACD above zero, trending and sloping higher. An added benefit would be stochastic recently oversold and turning upward, There are variations to this scenario, however, if price is above the moving averages we are bullish. If price is below, we are bearish.
Let’s look at an example.
RSI at point “A” represents an area of interest for a bullish trade. Generally, when RSI reaches this point we are more inclined to take bullish positions. When the index reaches an inflection point, we wait for a follow through day, as this bound indicator can stay embedded for a long time under extreme conditions. Once a trend in RSI starts to develop, our conviction can increase. We look for signs that momentum will continue.
In late June, RSI made a “V” shape turn at 30, with price at 4179.73. A hammer printed at this point. Stochastic was oversold (the green zone). MACD histogram built shorter bars as it turned higher, signifying a change to bullish momentum. Four (4) days after the low, price moved above the 9/20ema, SAR fired a “buy” signal, stochastic was trending higher and MACD crossed. A bullish change was confirmed.
Each day in the preceding example, note how MACD moved “away” from its signal line. As the distance increases, we know momentum is increasingly bullish, therefore we would stick with a long trade. Stochastic has a steep slope, aiding with trend confirmation.
A trader can safely add to positions on minor pullbacks to the ascending moving averages.
Conversely, if price is below the 9/20ema we have a bearish setup or edge. Look for rejection at the overhead moving averages and SOTEMA to be sloping downward as it did in December and again in mid-April. Ideally, RSI, MACD and stochastic will be trending lower, the opposite of the bullish condition outlined above.
Step Two: Sector Catalysts
Generally speaking, if all of the above conditions are bullish, we look for sectors to be oversold and turning higher using the late June example as a reference point or benchmark. In fact, all of the sectors were oversold and turning higher. This observation adds to our conviction. Ask yourself, where are the sectors? Are they overbought or oversold. Since we are thinking of a technology stock, what was the technology sector doing in late June? The answer is, technology bolted higher, adding to our conviction that most stocks in the industry would benefit from 1) Nasdaq bullish and 2) SPDR XLK sector bullish, with stochastic trending higher.
Step Three: Currencies and the USD
The dollar is used in trading goods and services, as well as bonds and equities, therefore its significance cannot be overlooked. A bullish move in the dollar usually accompanies equity weakness. Look for equities to move lower as the dollar strengthens. Currently, the dollar is on a SAR “buy” signal, which may lead to weakness in the short term. The Nasdaq chart above reflected a bullish bounce over the past week, as the dollar stayed relatively flat, in a 1.00 point range. That could change this week if the dollar breaks out of this triangle pattern. MACD is lifting above the zero line as well.
When the dollar falls in value, we look for a bullish move in equities. While this correlation does not always remain steadfast, it is a general rule. Look at the trend in the dollar from February through April; as it dropped equities came to life, rallying over 20%.
Monitor the dollar, commodities and equities for correlations that might impact your trading decisions.
Step Four: Commodities
If the dollar develops a bullish trend, very often commodities will move in the opposite direction, as it takes fewer dollars to buy the same basket of goods at 100, as it does with the dollar at 90. Look at the dollar and compare with the WTIC (crude) chart below during the same time period. As the dollar increased in value between late June and July, crude fell in price.
Step Five: Bonds/Yields
Recent bearish days in the indices were a direct result of a sudden appreciation in bond yields. Friday a week earlier,(9/9/16) saw equity prices shift lower across the spectrum, as yields rose suddenly. The market was spooked, as rate hike news hit the tape.
Generally speaking, we look for rising yields to provide a headwind for equities. Consider for example, the past 8 years have seen yields drop to historic lows, inflating equity prices in the process.
The table below helps explain what higher yields will do to various asset classes.
Systemize Your Trading
The process above, is a brief summary of the methods I use to mentally prepare for the trading day. Over time, if you use this process when weighing your potential candidates, you’ll develop an overall “feel” of the markets, that will help your decision process during the trading day. Additionally, you will begin to instinctively analyze a chart with “one glance” to determine if it’s even worth your time. Your trading prowess will improve dramatically.
In closing, I’m convinced critical thinking does not need to be tedious or exhausting. If you’re like me, this exercise will become your passion.
Follow a few rules and become an efficient trading machine. Trade with out a system and you can expect random results. The choice is yours.
Next time you are about to enter a trade, ask yourself where is price relative to the 9/20ema? The time frame doesn’t matter.
I hope this helps.
Happy Trading – Vinny