Trading Both Sides Of The Chart – Down Trends

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I began a discussion on when to use bearish positions in an earlier article. In that piece I focused on trading ranges and the use of oscillators like MACD, stochastic or RSI. Trading ranges, or the limits of those ranges, present high probability target areas in which signals can be taken, both bullish and bearish. They are also ideal situations for using overbought/oversold readings on your indicators as they often lead to and/or confirm the tops and bottoms of a ranging market. For this piece I am going to focus on an actual bear market. In general, even when we are in a secular bear market, stocks tend to go up slowly and fall quickly. It is not rare, but uncommon to find an asset in a true down trend but one you do it can provide a number of text book entries. I have been following a down trending asset for some time now, at least three years, and was inspired to write this article when I read Cory’s article about using another gold stock or index as an indicator of physical gold prices. I like to use the CBOE Gold Index, or GOX.

Long Term Down Trend In Gold

During the financial crisis of 2008-2009 the price of gold went through the roof, taking gold stocks and gold indices with them. At the peak, gold was trading over $1800, about 50% higher than the current levels. Since then, roughly 2020 or so, gold prices have fallen in a steady down trend with gold stocks moving right along with it. The down trend in the gold sector is a near perfect text book example and readily observed in numerous time frames. Along the way there are quite a few signals, bearish signals, to trade on. I know for me it was hard to learn just when to trade bearish and bullish as so many indicators can produce either form of signal at any given time. It took a while but I eventually began to understand the importance of trend, time frame and the relative value of any one signal at any one time. A bear signal in an uptrend isn’t a good place to get into a long term bearish position any more than a bullish signal in a down trend.

The first step is to identify the down trend. On the chart below it is easy to see the long term down trend in the GOX but how might you find it way back when it first started? That is the hard part and why waiting for confirmations are always a good idea. We can see that the index traded in a range during all of 2020 between two key Fibonacci Retracement levels. During this time range trading techniques and short term trend following strategies would have been a good idea. At the end of the year price broker the lower boundary, retested the moving average and produced bearish confirmation. This signal is still rather short term in nature but still a good place to buy puts, only there really isn’t a trend established yet. That happens later in 2020 when prices retest the previously broken 23.6% Fibonacci Retracement. Once that happens a well defined down trend ensues. At this time moving down to a chart of daily prices and even shorter to 1H or 30M will produce repeated trend following signals, signals identical to bullish signals, just in reverse. In fact, there are even some well defined longer trend signals as well. Look to the extreme right of the chart where I am tracking a pennant formation.

Bearish Entries For Short Term Traders

In this next chart I drill down to daily charts with a close up of the long term pennant mentioned above As we can see bearish traders are presented with a number of opportunities for entry along the boundaries of the pennant itself and the Fibonacci Retracement lines drawn on the bull trend leading to the down trend we are tracking today. There are at least, and I say at least, 16 positive bearish signals over the course of a year. This is great for patient traders with a long term outlook and also provides starting points for short term traders. Each time one of these signals appears on the daily charts that is your ticket to move down to a chart of short candles in order to capture the shorter term movements, always keeping in mind the underlying trend and taking only the bearish trades.

Studying old charts and historical price action is important to do. By studying old charts, drawing trend lines, playing with Fibonacci Retracement and identifying where the really good signals come from you get comfortable with them. This comfort level will help you with your trading because you will be better able to recognize new signals as they happen. Each new down trend will be different but in the end the market is always repeats itself and those repetitions will show up on your charts.

Trading Both Sides Of The Charts With Trading Ranges

What do I mean? Trading bear positions as well as trading bull positions. I know that I, and I suspect many newbies and advanced traders as well, started out learning to trade bull positions. It is easier and only natural as the tendency in trading and stock ownership is to buy low and then sell high. Another thing that may keep the average trader from entering a short or otherwise bullish position is margin and other account requirements associated with futures, forex and standardized options. The good news for binary options traders is that there is no limitation on your account and what you can trade so bearish strategies and techniques can be used with equal relish as bull ones, provided you make the right trades. That I think is the real reason why so many traders stick to bullish trading and/or have so much trouble trading bearish positions; they aren’t making the right trades.

When Not To Trade Bearish

There is one certain time when you should not make a bearish trade; when the market is bullish. This is a common mistake made by many new traders and I can say that because I have done it; trying to get bearish when the market is bullish. In general, even when we’re in a secular or long term bear market, the market is bullish. People want to buy stocks and when we are in a protracted bear market it is not so much because there are so many shorts in the market as it is that the buyers disappear. So, when the market is bullish it is not usually a good time to trade bearish but when is a good time? There are two key times in the market cycle when bearish positions are not only OK, but the preferred method of trading. The first is when the market is range bound and trending sideways, the second is when the market is in a well defined down trend. What makes up a well defined down trend may vary from trader to trader and depends greatly on time frame but once found is a fountain of profitable trades but that is for another time.

Trading A Range With Bear Positions

Ranges are great places to trade in a number of ways that include both bull and bear positions. The tops and bottoms of ranges are fantastic areas to look for reversal signals in the candlesticks and the indicators. In fact, ranges are perhaps the best place to use overbought and oversold readings on an oscillator. If the asset is up at, near or piercing the upper end of a range with overbought conditions on an indicator such as stochastic, RSI or MACD then chances are good a bearish strategy is the one you want. How do you know where the top of a range is? Usually it will be marked by a series of peaks or tops that stop at the same level with corresponding dips or bottoms that likewise stop at the same level. Look at the chart below. This a chart of daily price action for the EUR/USD US session. You can see that the pair has traded in a range from October 2020 until June 2020. This range is marked by Fibonacci Retracement levels and confirmed by price action about a dozen times, at least 6 at the top providing profitable entry each time.

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Once prices break above the 50% retracement line the first peak appears even before it reaches the next level. This peak is matched by a stochastic reading that enters overbought and produces a bearish crossover. The fact that the peak is appearing before reaching the next Fibonacci Level is one sign that prices will likely fall back to retest the 50% level and they do. The next signal is a bullish one but one that confirms a longer term range could be in play. The next peak, the next two peaks in fact, also occur once price approaches the upper range limit along with an overbought stochastic and bearish crossovers. Additionally, the first divergence is seen indicating an underlying weakness in the market. The next three peaks also come as price action reaches the upper limit of the range. They are also confirmed by overbought stochastic readings, bearish crossovers and a growing divergence that leads to a protracted visit to the low end of the range. The thing to take not of here is that this is a ranging market, even if you only get into trades based on this strategy on the 3 rd or 4 th peak you have made two great trades.

I used Fibonacci Retracements as the basis for my range. You can use other methods to mark a range such as simple support and resistance lines. You also do not have to limit your self to any one time frame although I prefer to use daily charts. Hourly and 30 minute are just as useful, especially for day trading. Take a look at the chart above of the AUD/USD. This is a chart of daily prices with support and resistance drawn at likely places. Resistance is being tested while candle action supports the possibility of a range top. Even without the range theory in place this is an attractive area for bearish strategy and is confirmed by, you guessed, an overbought stochastic with a bearish crossover.

Click here for more information on trading with Fibonacci Retracments and here to learn about using oscillators like stochastic and RSI.

Trend Trading: The 4 Most Common Indicators

Trend traders attempt to isolate and extract profit from trends. There are multiple ways to do this. Of course, no single indicator will punch your ticket to market riches, as trading involves factors such as risk management and trading psychology as well. But certain indicators have stood the test of time and remain popular among trend traders.

In this article, we provide general guidelines and prospective strategies for each of the four common indicators. Use these or tweak them to create your own personal strategy.

Moving Averages

Moving averages “smooth” price data by creating a single flowing line. The line represents the average price over a period of time. Which moving average the trader decides to use is determined by the time frame in which he or she trades. For investors and long-term trend followers, the 200-day, 100-day, and 50-day simple moving average are popular choices.

There are several ways to utilize the moving average. The first is to look at the angle of the moving average. If it is mostly moving horizontally for an extended amount of time, then the price isn’t trending, it is ranging. If the moving average line is angled up, an uptrend is underway. Moving averages don’t predict though; they simply show what the price is doing, on average, over a period of time.

Crossovers are another way to utilize moving averages. By plotting a 200-day and 50-day moving average on your chart, a buy signal occurs when the 50-day crosses above the 200-day. A sell signal occurs when the 50-day drops below the 200-day.   The time frames can be altered to suit your individual trading time frame.

When the price crosses above a moving average, it can also be used as a buy signal, and when the price crosses below a moving average, it can be used as a sell signal. Since the price is more volatile than the moving average, this method is prone to more false signals, as the chart above shows.

Moving averages can also provide support or resistance to the price.   The chart below shows a 100-day moving average acting as support (i.e., price bounces off of it).

MACD (Moving Average Convergence Divergence)

The MACD is an oscillating indicator, fluctuating above and below zero. It is both a trend-following and momentum indicator.

One basic MACD strategy is to look at which side of zero the MACD lines are on in the histogram below the chart. Above zero for a sustained period of time, and the trend is likely up; below zero for a sustained period of time, and the trend is likely down.   Potential buy signals occur when the MACD moves above zero, and potential sell signals when it crosses below zero.

Signal line crossovers provide additional buy and sell signals. A MACD has two lines—a fast line and a slow line. A buy signal occurs when the fast line crosses through and above the slow line. A sell signal occurs when the fast line crosses through and below the slow line.

RSI (Relative Strength Index)

The RSI is another oscillator, but because its movement is contained between zero and 100, it provides some different information than the MACD.

One way to interpret the RSI is by viewing the price as “overbought”—and due for a correction—when the indicator in the histogram is above 70, and viewing the price as oversold—and due for a bounce—when the indicator is below 30.   In a strong uptrend, the price will often reach 70 and beyond for sustained periods, and downtrends can stay at 30 or below for a long time. While general overbought and oversold levels can be accurate occasionally, they may not provide the most timely signals for trend traders.

An alternative is to buy near oversold conditions when the trend is up and place a short trade near an overbought condition in a downtrend.

Say the long-term trend of a stock is up. A buy signal occurs when the RSI moves below 50 and then back above it. Essentially, this means a pullback in price has occurred, and the trader is buying once the pullback appears to have ended (according to the RSI) and the trend is resuming. The 50 levels are used because the RSI doesn’t typically reach 30 in an uptrend unless a potential reversal is underway. A short-trade signal occurs when the trend is down and the RSI moves above 50 and then back below it.

Trendlines or a moving average can help establish the trend direction and in which direction to take trade signals.

On-Balance Volume (OBV)

Volume itself is a valuable indicator, and OBV takes a lot of volume information and compiles it into a single one-line indicator. The indicator measures cumulative buying/selling pressure by adding the volume on up days and subtracting volume on down days.

Ideally, the volume should confirm trends. A rising price should be accompanied by a rising OBV; a falling price should be accompanied by a falling OBV.

The figure below shows the shares of Netflix Inc. (NFLX) trending higher along with OBV. Since OBV didn’t drop below its trendline, it was a good indication that the price was likely to continue trending higher after the pullbacks.

If OBV is rising and the price isn’t, price is likely to follow the OBV and start rising. If the price is rising and OBV is flat-lining or falling, the price may be near a top. If the price is falling and OBV is flat-lining or rising, the price could be nearing a bottom.

The Bottom Line

Indicators can simplify price information, as well as provide trend trade signals or warn of reversals. Indicators can be used on all time frames, and have variables that can be adjusted to suit each trader’s specific preferences. Combine indicator strategies, or come up with your own guidelines, so entry and exit criteria are clearly established for trades. Each indicator can be used in more ways than outlined. If you like an indicator, research it further, and most importantly, test it out before using it to make live trades.

Learning to trade on indicators can be a tricky process. For those who have yet to enter the market or start trading, it’s important to know that a brokerage account is a necessary first step at getting access to the stock market.

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