A popular market breadth indicator, the McClellan oscillator is one of the tools that MoneyShow's To...
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
Related Articles on TRADING
While fundamentalists delve into economic and financial data to analyze the market, technicians emp...
Being able to determine market direction is a trader’s most important skill, writes Markus He...
Markus Heitkoetter discusses reward/risk ratios and winning percentage, and why determining the dir...