It's been nearly a month since the last ezine. Sorry for the delay, but I've been a little busy. I've rewritten the GapDown book and it will be released in a few months as a multi-media package.
I have talked in my blog and in previous ezines about using Moving Averages. I've also talked in my recent blogs about those who predict the future direction of the market. So, in this ezine, I want to pull some of that together. It's an appropriate time to look at the larger charts before we begin the quaterly earnings reports this week.
There are many technical indicators you can use when trading. Some of this is like a self-fulfilling prophecy. If thousands of people trade a market based on a set of common indicators, then they tend to make that indicator true. Among the indicators widely used by longer term investors is the Moving Average. More specifically, many investors use Moving Average ribbons. A ribbon is constructed by plotting various moving averages on the same chart. Most charting software packages will allow you to do this. You can make each one a different color. The intersection of these various ribbons is where the future of a stock price is often determined - or, at least it is one way to measure that direction.
For example, you may have heard me mention that I use a 2 and 4 SMA (Simple Moving Average) in my day trading. This is just one among many things I look at. And what I am watching for are the moments in the life of a stock when those moving averages intersect.
I have also previously mentioned how a candle that meets with the mid-line of the Bollinger Band will either bounce back up or fall through that line, depending on other indicators. That mid-line is simply another type of SMA ribbon.
I won't go into it here...but, one of the things you can study is what happens when a price candle intersects with a specific moving average. For example, if the 18-SMA is trending upward and the one-hour candle intersects with that line, how likely is that price to reverse and bounce back up? Well, something that should come to mind is the fact that eventually all prices cross that line. They cross that line repeatedly because prices do not go straight up. And, since this is true, there must be another indicator(s) that can help us determine which way that price will go, once that intersection occurs.
Hope I haven't lost you already. But, what we're examining is the fact that SMA ribbons can act as either support or resistance. And I'm suggesting that there are other indicators to examine when this intersection occurs, to help us determine if we should buy long or sell short.
So, to pull all of this together, let's look at a chart of the Dow Jones Industrial Average.
I've drawn a line on this chart to show the Dow at 8000. Prior to mid-February, this mark had been a line of support. Price did not want to go below this line. But the Dow finally broke through this line and bottomed out around 6500.
I have drawn SMA ribbons for 7, 20, 50, and 100 SMAs. As you can see on the chart, we are currently at a critical intersection - one in which that line of support (8000) has become a line of resistance. And the question on everyone's mind is this: will the Dow break above that line of resistance and continue the rally, or will it retreat?
Now, I am not trying to predict the future here. So please don't misunderstand me. But, I think it's interesting to study the charts and see if they give us any kind of guidance. Personally, I am mixed. On the one hand I think a 5-week rally is pretty good in light of the current economy and therefore the market may pull back a bit. Then again, the market seemed to take the bad reports in stride last week and rally (big-time with financials) around the good reports.
On the above chart, you could also draw a current line of support between 6500 and 8000 - maybe around 7500. I don't think the market will go much below that, if it goes anywhere close. But I've also drawn two trendlines on the RSI indicator.
In late February and March, you can see how RSI stayed below the 30% line. But, you can also see how RSI's dip was a little less each time. So, the RSI was trending higher, even as price continued to fall. Finally, RSI passes the 30% line after March 9th, and price began to soar.
Now, however, we see the opposite happening. Even as price has moved up in the rally, RSI has peaked a little less each time. It's current trendline is going down, even as price moves up.
Does this mean we will return to a steep decline in the Dow? I don't know. But, as price moves up and strength moves down, it makes me think we'll see resistance at the 100 SMA intersection.
We'll have to wait and see.
So what practical importance is all of this? Whenever we're at a technical intersection, it is wise to be careful. Being either overly optimistic or overly pessimistic would be an error, in my opinion. But, if I had to lean, I would lean down not up.
Perhaps you can add some of these SMA ribbons to your own charts and see if they help you with your trading. But, as I've demonstrated on this chart, always combine them with other indicators. You can use RSI and you can also use Stochastics.
Hope you have a good trading week.
We'll be making an announcement very soon about the upcoming chat room. May 1st is the start date. I'll be leading a daily chat room each morning and we'll be trading gap ups and gap downs every day. So, if you're interested, then stay tuned to the next ezine and the daily blog posts.
Enjoy your trading,