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Posted In Day Trading Blog | 99 comments You might have heard the saying "The Trend Is Your Friend" and that you should "Trade The Trend." But sometimes this is easier said than done. In this article I will show you an easy easy to identify and trade the trend. How To Identify A Trend Way back in the 90s I used fundamental analysis to try and predict the market. Long story short, it didn't work for me. Since the mid 90s I have been using technical analysis in my trading. When using technical analysis, there are two different approaches:
Examples of chart patterns are flags, pennants, triangles, double bottoms and tops, etc. Candlestick formations are chart patterns, too. Examples of indicators are moving averages, Bollinger Bands, MACD, RSI, etc. So which approach is "better"? Should you use chart patterns or indicators to identify the direction of the market? Easy answer: Use the approach that works for YOU. I personally use indicators. I like the black-and-white approach of indicators. As an example, the RSI is either above 70 or it is not. There's no grey area. I openly admit that I struggle identifying chart patterns while they are forming. Don't get me wrong: I am an expert showing you every single chart pattern there is at the end of the day. But I can't identify them with certainty while they are forming. But hey, I can't ride a bicycle either, so maybe there's something fundamentally wrong with me Using Indicators To Identify The Direction Of The Market In my own trading I use THREE (3) INDICATORS to determined the direction of the market and trade the trend. Today we will talk about the my favorite indicator - Bollinger Bands. Bollinger Bands are a fascinating concept. They are available in EVERY charting software. Note: If your charting software does NOT allow you to plot Bollinger Bands on your charts, it's time to switch to a different software provider. Let me know if you need help finding a powerful charting
software platform Back to Bollinger Bands. Bollinger Bands consist of a CENTERLINE, which is a simple moving average, and two standard deviations. One above the centerline and one below. These are called the UPPER BOLLINGER BAND and the LOWER BOLLINGER BAND. I like to use a setting of 12 for the moving average and a setting of 2 for the standard deviation. And here's how to use Bollinger Bands to identify and trade the trend: In an uptrend you will see that the Upper Bollinger Band in pointing up in a nice 45 degree angle and prices are touching the Upper Bollinger Band. The Upper Bollinger Band acts like a trendline ABOVE the prices.
So how do you know when an uptrend is over? The uptrend is over as soon as the Upper Bollinger Band flattens or turns around.
In a downtrend you will see that the Lower Bollinger Band in pointing down in a nice 45 degree angle and prices are touching the Lower Bollinger Band. The Lower Bollinger Band acts like a trendline BELOW the prices.
And the downtrend is over when the Lower Bollinger Band flattens or turns around.
Can YOU Identify And Trade The Trend? Try it out for yourself! 1. Pull up your charting software, plot the Bollinger Bands on the charts with a setting of 12 for the Moving Average and 2 for the Standard Deviation 2. You can use it with ANY timeframe, but if you are day trading, you might want to use a five (5) minute chart. 3. Look at the current value of the Upper and Lower Bollinger Bands. Based on the definition that I gave you above, what is the market doing right now? Is it in an uptrend or in a downtrend? 4. Now look back at charts. Can you see how the Bollinger Bands are showing you how to trade the trend? You shouldn't have ANY difficulty to determine whether a market is going up, down or sideways based on this simple definition. If you do have problems, let me know and I'll be happy to help. Keep in mind that this is NOT a trading strategy in itself! It's just a way to determine the direction of the market and identify a trend. Summary You can use chart patterns or indicators to help you identify and trade a trend. I personally rely on indicators because for me they are more "black and white". My favorite indicator are the Bollinger Bands. They offer me an easy way to determine whether the market is trending or going sideways. Does this help?
Gap Trading - Trading With Probabilities Posted In Day Trading Blog | 1 comment Estimated Reading Time: 6 Minutes "Gap trading" is a simple and disciplined trading approach. When gap trading, you don't need any indicators. You only need to find a market that has a price gap from the previous close to today's open. More often than not prices tend to move towards the direction of the previous close, presenting excellent trading opportunities. In this article I want to show you some ideas how to trade them. It's All About Probabilities Depending on where the market opens today in relation to yesterday's close, we see either a full gap or a partial gap. Scott Andrews from www.MasterTheGap.com has been doing some extensive research about the probabilities of a gap fill.
Gap Trading Probabilities (courtesy of www.MasterTheGap.com) The above picture shows the winning percentage for various gap opening scenarios for the e-mini S&P based on more than 2,150 opening gaps between 2002 and 2011. In this graphic the historical win rate in the S&P 500 E-mini futures for each zone is shown and assumes you faded the gap at the open and held for gap fill (prior day close i.e. thick, yellow line) or until the end of the day if gap did not fill. Let me explain the different gap trading zones: All zones starting with "D" are gap trading zones after a "down day", i.e. the previous day's close was below the previous day's open. Here are the different scenarios:
D-H (54% historical winning percentage) If today's open is above yesterday's high, then there's a 54% historic winning percentage of prices moving to yesterday's closing price. D-HO (61% historical winning percentage) If today's open is above yesterday's open, but below yesterday's high, then there's a 61% historic winning percentage of prices moving to yesterday's closing price. D-OC (74% historical winning percentage) If today's open is between yesterday's open and close, then there's a 74% historic winning percentage of prices moving to yesterday's closing price. D-CL (83% historical winning percentage) If today's open is below yesterday's close, but above yesterday's low, then there's a 83% historic winning percentage of prices moving to yesterday's closing price. D-L (64% historical winning percentage) If today's open is below yesterday's low, then there's a 64% historic winning percentage of prices moving to yesterday's closing price.
Scott identifies similar zones after an "up day, i.e. the previous day's close was below the previous day's open. Here are the different gap trading scenarios after an "up day":
U-H (65% historical winning percentage) If today's open is above yesterday's high, then there's a 65% historic winning percentage of prices moving to yesterday's closing price. U-HC (85% historical winning percentage) If today's open is above yesterday's close, but below yesterday's high, then there's a 85% historic winning percentage of prices moving to yesterday's closing price.
U-CO (74% historical winning percentage) If today's open is between yesterday's open and close, then there's a 74% historic winning percentage of prices moving to yesterday's closing price. D-OL (65% historical winning percentage) If today's open is below yesterday's open, but above yesterday's low, then there's a 65% historic winning percentage of prices moving to yesterday's closing price. U-L (48% historical winning percentage) If today's open is below yesterday's low, then there's a 48% historic winning percentage of prices moving to yesterday's closing price.
Not All Gaps Are The Same As you can see, opening gaps in general have a strong tendency to trade back to the prior day's closing price (65-70%), but depending on today's open in relation to the previous day's open, high, low and close, sometimes the probabilities are higher than average. You don't have to trade every single gap - focus on the high probability gaps! The name of the game is not trying to catch all of the winners, but rather to avoid most of the losers. As an example, why do you think gaps in the U-L zone (bottom right of the Gap Zone Map - see above) show such a low historical win rate (48%)? Scott Andrews believes it's because gaps opening in this zone are catching traders positioned to the long side off guard, triggering many sell stops in the process. Plus, such an obvious reversal from the prior day surely attracts new short sellers who want to jump on board the beginning of a new potential trend. Gap Trading In A Nutshell When looking for gaps, obviously you want to exclude the "overnight session" and only focus on the "day session" of the markets. ANY market and even stocks are suitable for gap trading. The above graphic shows the historic winning percentage of the e-mini S&P. As you can see, the odds are in your favor when trading gaps, but keep in mind that past performance in not necessarily indicative of futures results. Pick the highest probabilities. As I said before: It's not about trying to catch all of the winners, but rather to avoid most of the losers. With that in mind, give gap trading a shot. You can do it with ANY charting software, since you don't need any indicators or other fancy tools.