Trading From Main Street

[Brandon]

One of the great things about price patterns is that the truely good ones, the ones that have a valid ideology behind them are fractal..that is, you can take the same idea and apply it to any time frame. You can take the Marabozu pattern, which we traditionally use as a daytrading setup, and using the exact same concept apply it on a weekly, monthly or quarterly chart allowing you to utilize it in your longer term trading plan. You can also take the idea behind the core Core Swingtrade Buy setup and apply it to longer term time frames giving yourself the ability to use this powerful concept in longer term trades. You can also shorten the time frame,and with some slight modifications have yourself a very profitable daytrading methodology. That will be my focus here.
This entry setup is very simple needing only a few things. You need a liquid (over 1million shares a day) volatile (with at least the same volatility as the SP500) stock to start with that is trending. Next you need a 13 minute chart, a 20 period exponential moving average and a 3 period Relative Strength Index (RSI). I will briefly explain each tool before moving on to the setup and its application. Im going to keep it very simple, they can easily become more complicated than they need to be leading to inaction.

Not to be confused with Relative strength, which is simply how a stock is performing relative to the major averages, The RSI is an overbought/oversold indicator, much like stochastics. It was developed in the late 70's by Welles Wilder and is one of the more reliable of the popular technical indicators. The RSI is an oscillator that measures the relative internal strength of a stock or indexes average upward price movement against its average downward price movement over a selected time frame. The shorter the timeframe the more sensative it will be. Didnt get all that? Dont worry...I dont really either. Here is the important part: An RSI reading over 70 is overbought and an RSI under 30 is oversold. Just be sure to remember that last part, its the one that matters.

For this setup, I use an exponential moving average rather then a simple moving average. Exponential moving average give greater weight to more recent price data than do simple ones and are thus more sensative to recent data. Why do I use an exponential moving average for this setup and not a simple moving average? For the same reason in other cases I use a simple in place of an exponential...it works better

The setup here is fairly simple and straight forward. First you want to be able to look at the stock or index and see that its fairly obviously trending. Once that is established, when its above the 20ema you are looking for long setups. When its below the 20ema you are looking for short setups. Trending stocks often have the counter trend moves and become overbought/oversold before moving again in the direction of the trend. These can often be very strong moves. The RSI set at 3 periods gives us a very sensitive measure of overbought and oversold. When the stock is uptrending and above the 20ma on the 13minute chart, once the RSI triggers oversold, you go into a buy alert. The actual buy setup will occur once the stock trades above the prior bars high on the 13minute chart. The alert will remain valid for two bars. On the short side you want to see the an obvious downtrend in place on the 13 minute chart. The stock must be trading below the 20ema and then go to overbought. The short is triggered below the prior bars low and again the alert remains valid for 2 bars.

I will use PDLI as an example for this setup. We had an earlier trade in PDLI which resulted in a small loss, and then I mentioned that I was again watching the stock. When it setup I had stepped out an so we all missed it. But, since its right here and was something mentioned I will go ahead and walk you through the setup. URL is http://www.swingtrader.net/RTRcharts/PDLI.gif

As you can see when you look at this chart, PDLI is in an obvious uptrend. Its making higher highs and lows on this time frame. Todays early action was very strong and the stock took the opportunity to rest and pullback. The pullback gave us an oversold reading on the 3 period RSI. Once this is in effect the long trigger is above a bars high. So, on the very next bar, the $80.06 high was taken out and long positions can be taken. Stops are placed 79.19 which is the bars low. As we can see the stock is doing very well. Trade mgnt is pretty standard. Once you are up an amount equal to your initial risk go ahead and move the stops to breakeven and manage the trade.

If you take trades using this setup a few things are pretty important that I have found. First of all make sure you dont take trades on alerts, only the setup. That should be obvious. Also, if you dont have a liquid, volatile stock that you can see a trend on when you look at the chart, your going to go broke.

Enjoy,
Brandon