Three Tactics to Improve Our Trading Knowledge
By Jay Norris
1. MACD-Histogram The MACD stands for Moving Average Convergence-Divergence and is represented by 3 moving averages converted to two lines, one fast, and the other slow. The MACD- Histogram measures the difference between these two lines and plots it in histogram form, making it easier to visualize, and providing us with a great indicator to help us determine when a market is pausing, or reversing. The MACD - moving average cross overlaid on the histogram - is an excellent indicator to help you determine first a market’s direction, then how to position yourself in a market, and most important, how to let a profit run once you’re in a trade. I once asked Bill Williams, the author of Trading Chaos, (2nd Edition, Wiley, 2004) to identify the most important thing to know in trading. Without hesitation, he told me that it was learning how to let a profit run. When trading, or holding a position, there is always plenty of market noise in the way of news developments or intraday skittishness, and the MACD proves a great filter to eliminate much of that. The rule of thumb is if the two lines – moving averages – are holding apart, or even better, angling away from each other, let the profit run. (For settings I use the 12,26,9 C which is the default setting for most chart packages, including the free realtime chart package which comes with the futures firm that I use and recommend). On the chart below I’ve marked the positive crosses which indicate a market with a sideways to upward bias, and the negative crosses which indicate a sideways to downward bias. You can see that by using this indicator you are given a market bias. You will avoid being short any time the blue line is above the red line. Likewise you avoid being long when the red line is above the blue line. It’s also important to know to not make a trading decision until the current bar is closed, or expired.
The MACD-Histogram is a directional as well as a momentum measuring indicator and also very helpful in determining divergence in a particular market. While we use the MACD to help us with the direction and timing of a trade, we do not use it to give us actual trade triggers, but more a tool to confirm the trigger. Again the most important use to me for this indicator is using the MACD – the moving average cross -- to assist my decision making process in letting a profit/market run.
2. Viewing Several Time Frames at Once I first read about using several different time frames, or trading screens, in Dr. Alexander Elder’s book, Come into My Trading Room (1st Edition, Wiley, 2002). Dr. Elder explains that it is far easier for us to view different time frames simultaneously than to try to flip back and forth between screens, or between time frames. The tactic really comes in handy when filtering out signals on shorter time frames, waiting for a higher time frame to confirm. For position trading I will use daily, 240, and 60 minute charts. In order to take a trade trigger on a lower-time frame, the next higher time frame must confirm. For short-term trading I will use 60, 15 and 5 minute charts, but will also be familiar with the trend, and significant levels on the daily chart. I can also use a smaller time frame to take a trade trigger on a higher time frame earlier than I might if I wait for the bar to close on the higher time frame – one of the tenets in my trading plan is to only make a trading decision after the candle is complete, or closed. An example of this would be if we had a doji - possible reversal candle - on a longer-term support line on a 15 minute chart. Rather than wait for a candle to close above the high of this candle on the 15 minute chart, I can consider taking the trade once the market closes above the high of the doji on a 5 minute chart – the same would hold true for a 60 minute and 15 minute chart, or a daily and 240 minute chart. We can also use technical indicators on different time frames to aid us if we are trading from more than one chart. For example I was taught to have a stochastic and a RSI on my charts, along with the MACD. I might see a crossover of the MACD on the 15 minute chart, but I also want to see the Stochastic, RSI, and MACD Histogram on the 60 minute charts turn up for confirmation before committing to the trade on the lower time 2
frame. I may write in my trading plan that I can take a buy signal on the 15 minute chart, but only if it’s accompanied by a rising RSI on the 60 minute and an up tick on the MACD-histogram. A strategy of checking off indicators on the longer-term time frames to confirm signals and triggers on the short-term charts is a common tactic for seasoned traders, and one, in my opinion, that is not used or understood enough by people first learning to trade. I always have at least three time frames in front of me when I trade, usually keeping the shortest on my top screen and the longer-term ones below. It is important that you are able to see different time frames simultaneously, rather then rely on your own memory when clicking back and forth. By viewing them all at once you’ll stay much calmer, and I suspect, get in the groove quicker, than you would by straining your thought process trying to coordinate the time frames separately. The chart package you use should allow you to place as many charts up on the screen as you need. Below is a daily chart of the Yen in the forex market. I’ve drawn a bull trend off the previous lows to help visualize the current trend and help us identify potential levels. Below that I’ve dropped down to a 60 minute chart so we can see the same trend line on a lower time frame, and below that chart I’ve taken a snapshot of the 15 minute chart to see the actual buy signal.
Below we see the same market and time on a 60 minute chart. See how the market walks that daily trend-line on the shorter-time frame, with the technical indicators turning up prior to a nice intraday rally?
Below is a 15 minute chart of the same market, at the same time. We see the MACD rising on this chart prior to the intraday rally. By tying 3 time frames together like this we’re able to take this intraday signal with a bit of confidence as we see it initially hold the support of the trend-line on the daily time frame, before consolidating and rallying.
3. Trading Sideways Channels Another must-know trade tactic is the sideways channel break out. Once the market closes above the high or low barrier of a sideways channel, or saddle point, we take this as a trigger and go with the direction of the market - breakout. It’s important to wait for the candle, or price bar, to close outside the channel before committing to the trade. To get better positioning we may take the trade on a close outside the range on a 15 or 5 minute chart, but if we do not get a close outside the range on the next higher time frame we must be quick to exit the trade. The stop loss on the trade would be 2 or 3 closes back above, or below the range, or a move counter to our position by the MACD-Histogram on a closing basis on the time frame we’re trading. Should the trade move in our direction we would then key off the MACD - moving average cross overlaid on the histogram -- to aid in letting the trade run. Also of importance in a sideways trading range is to know that the technical indicators - stoch, RSI and MACD - are of little consideration, as the upper and lower limits of the range supersedes them. Also of note when dealing with sideways ranges is that it is more likely that the market will break out of the range in the same direction from which it entered the range. If the market was moving lower, 5
then consolidated in a sideways range, it is more likely to break out lower. Below is an example of this and it brings home the importance of waiting for a close outside the range before committing to the trade.
There is nothing new in these three tactics. This tutorial is meant as a refresher for experienced traders or as a brief introduction of these tactics to traders who have not previously heard of them or perhaps have not fully understood them.
Click Here to learn more Trading Tactics!
Jay Norris jnorris@BrewerInvestmentGroup.com Senior Market Strategist Brewer Futures Group, LLC 800-971-2154 DISCLAIMER: Futures, Forex and options trading involves substantial risk of loss and is not suitable for every investor. The valuation of futures, Forex and options may fluctuate, and, as a result, clients may lose more than their original investment. The impact of seasonal and geopolitical events is already factored into market prices. In no event should the content of this correspondence be construed as an express or implied promise, guarantee or implication by or from Brewer Futures Group, LLC, Brewer Investment Group, LLC, or their subsidiaries and affiliates, that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Information provided in this correspondence is intended solely for informational purposes and is obtained from sources believed to be reliable. Information is in no way guaranteed. No guarantee of any kind is implied or possible where projections of future conditions are attempted.