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How to Trade on Trend Days
09/02/2013 6:00 am EST
It’s important to know what not to do on a trend day so you don’t give back hard-fought profits from trading normal sessions, writes technician Corey Rosenbloom of AfraidToTrade.com.
August 27’s intraday trading session gave us a great example of early recognition and trading tactics on trend days as they develop. Let’s take a brief moment to learn the lessons from this textbook trend day session.
5-min @ES E-mini ‘trend day’ basic chart:
We’ll be using the @ES (S&P 500) and @YM (Dow Mini) futures for examples, but the lesson extends not just to other index futures traders, but index ETFs, or even leveraged index ETFs.
We’re seeing the five-min chart with the 20- and 50-period exponential moving averages (EMAs) and the standard Bollinger Band indicators just to keep it simple.
We generally use the following rules to identify trend days as they develop:
- Watch pre-market news or catalysts (in this case, the escalation in Syria)
- Make a note of Asian/European Markets and pre-market US futures (large gap down)
- Make a note of any large opening gap (a large gap increases the odds of a trend day developing)
- Monitor the first hour’s price action for any fill of the gap (no fill also increases the odds of a trend day)
With a trend day likely in motion, the trading strategies should be simple and focused on price—mainly trading pro-trend retracements or “flag” set-ups and avoiding all reversal/fade trades.
Depending on your risk-tolerance or experience, a retracement trade entry triggers one of two ways:
- Aggressive traders short-sell INTO a falling 20- or 50-EMA (or trendline)
- Conservative traders short-sell on a BREAK under a rising ‘flag’ trendline or five-min reversal candle low
On the charts, aggressive entries are labeled as “A” while conservative entries have the “C” label.
Similarly, your stop-loss strategy will depend on your risk-tolerance and experience level.
- Aggressive traders can trail a stop further away from entry, between the 20/50 EMA or above the 50 EMA.
- Conservative traders tend to place a stop—and trail it—just above the falling 20 EMA.
Finally, the target or ‘profit exit’ strategy also depends on your individual risk tolerance:
- Aggressive traders tend to hold as long as possible, exiting on a break above a falling trendline or reversal candle high.
- Conservative traders may exit on a ‘poke’ outside the lower Bollinger Band or test of the prior price swing low.
Some aggressive traders hold a core position as long as price continues to trade under the 20 EMA (exit near close).
We can see four clean examples of this method on the @ES (above) and @YM (below) 5-min charts:
One of the powerful drivers of a trend day is the sudden shock to the system and large-scale shift in the supply/demand relationship. That’s why fade or reversal strategies tend to fail spectacularly on trend days.
Perversely, traders who fight or fade a trend day often help propel the trend in motion with their stop-losses—it’s very important to understand this fact.
Though trend days aren’t as common as normal or range days, it’s important to know what NOT to do on a trend day so you don’t give back hard-fought profits from trading ‘normal’ sessions.
Building on that foundation, we can apply simple retracement or pro-trend strategies as long as the trend day continues, which objectively would be as long as price remains ‘trending’ beneath the 50 EMA on a five-min chart.
A breakthrough above the 50 EMA tends to trigger a “rounded reversal,” but that’s a whole other topic for later.
By Corey Rosenbloom, CMT, Trader and Blogger, AfraidToTrade.com