While today's volume was light, I think the big take-away from today's action was GE closing decisively above its 200dema on higher volume. My observation from the last two weeks is that while the indexes are steadily grinding higher, leading stocks are taking turns at the point. This is perhaps giving some traders the impression that the trend is not as strong as it really is. A shakeout may be just a day away, but don't get caught in the misguided short crowd.
I had (made) an opportunity to sit down with one of my 13 year old sons this weekend and show him some interesting things on the charts. He is a math whiz, 3 grades ahead of his peers, and he asked me how I know what the stock market is going to do. I told him, the fact is - I don't. I have learned a great many methods for predicting turning points and cycles in financial markets, but they are not the basis for my trading. They only inform my trading. I explained to him that the key is not what we think the market is going to do, but what is it doing. I then showed him how we calculate exponential moving averages and a monthly chart of the SP500 with 6 and 12 month emas. I pulled out a 60 year old book I found at a yard sale that described how to determine the secular trend, and explained that is what we are doing with the moving averages. We then calculated the return from 1991 to the present of going long on a positive cross and short on a negative cross of the moving averages. It worked out to about 22% annualized with just 4 trades. He got it right away. Why bet on a bet, when you can just bet.
I know that it is hard to believe given what I just posted a few days ago about so many traders losing money, but it really is that simple, almost. Of course there is all of the mechanics of position sizing, risk assessment, targets, etc, but those can be learned.
Now, I am reading almost daily that the market is topping, that it is time to get short, ad nauseum. But take the time to look at a chart of the SP500 with the 6 and 12 emas on it without any other indicators. First look at the monthly. The 6 is just about ready to cross up the 12. Then look at the weekly. The 6 is greater than the 12 and pointed up. Then look at the daily. The 6 is greater than the 12 and pointed up. Sure, I'll grant you that momentum may be waning a bit, but with stocks like GE breaking out on a rotating basis, are you sure you really want to short this market?
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2 comments:
Craig,
Have you found using the 6 ema and 12 ema to be good moving averages to indicate trend direction?
Thanks.
Gary
Gary,
I have definitely found that using a pair of ema's in a 1:2 ratio to be very useful in evaluating trend direction.
For example, the 5 & 10, 6 & 12, 12 & 26, 26 & 50, 50 & 100 or 200.
In order to be successful with this approach, you need to use the Triple Screen approach as advocated by Elder in his books, which is to look for agreement on the Monthly, Weekly & Daily EMAs, or use another something like Marketclub's monthly triangles for trend and the EMAs for trading signals.
You will also need to choose whether a) you are going buy a pullback with a limit order after a long signal, or b) you are going to wait for a pullback and then buy a breakout with a stop-limit order. Either way, the most important thing is to be consistent.
I generally use a 3 ATR stop, unless there is a very clear, closer pattern stop.
You must also realize that the win rate will be less than 60%, but better if you use the filters recommended above.
Finally, for stocks I generally do not trade the daily time frame with this approach, the monthly and weekly work best.
Hope that helps.
Craig
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