2021 is just around the corner and chartists without a strategy should think long and hard about getting one. Trading in the direction of the trend is pretty much my bread and butter strategy. I do not fish for bottoms or attempt to pick tops. Tempting as it often is, I try to refrain from such endeavors as much as possible.
More often than not, we are better off using trend-following indicators to identify bullish and bearish trend reversals. These indicators are not perfect because they will lag and there will be whipsaws. But there will also be a few good trends along the way. Once a trend is established, I then use short-term momentum indicators and bullish continuation patterns to identify tradeable pullbacks. This article will show how to use Full Stochastics to identify trends and two momentum indicators to identify setups within bigger uptrends. We will also highlight a few short-term bullish continuation patterns on the charts.
Long-term Stochastics for Trend Following
The Full Stochastic (125,5,1) can be used as a proxy for StochClose (125,5), which is available as a part of the TIP Indicator-Edge Plugin on StockCharts ACP. StochClose uses closing prices only for the high-low range, while the Full Stochastic uses the intraday high and low in its calculation. This often results in a slightly wider range and spike highs or lows can sometimes skew the range.
The Full Stochastic (125,5,1) and StochClose (125,5) measure the location of the close (last price) relative to the high-low range over the lookback period, which is 125 days and covers around six months). A 5-day SMA is added for smoothing. Price is firmly in the upper half of the six month range when above 60 (uptrend) and in the lower half when below 40 (downtrend).
Six months hits the sweet spot for the trend and my trading style. Three months is a little too short and nine months is a little too long. We all want to catch trends early and reduce whipsaws, but there is no such thing as the perfect indicator with the perfect settings. It is often best to pick a logical timeframe that suits your trading or investing style and stick with it.
Weekly Charts for More Persepective
I prefer daily charts because I can capture the six month trend (125 days) and still get granularity for short-term setups in one chart. Some chartists prefer weekly charts and weekend analysis. Not to worry because indicator settings can be adjusted accordingly. The weekly chart below shows the Semiconductor ETF (SOXX) with Full Stochastics (26,2) adapted for the six month timeframe. The red and green vertical lines show the bullish and bearish trend signals.
The middle indicator window shows StochRSI(5), which is the Stochastic Oscillator applied to RSI. This measures the momentum of momentum (RSI on Red Bull). I only use this to identify short-term pullbacks or consolidations within a bigger uptrend. Thus, this occurs when the bigger trend is up (Full Stoch bullish) and StochRSI moves below .20 (vertical gray lines). After the weekly close, chartists can use StochRSI to find trading candidates for the coming week or two. These candidates can then be charted using daily, or even intraday, bars for more granularity.
Five Stages of a Trade
There are five stages to a trade: setup, entry signal, monitoring, exit signal and waiting. Yes, waiting is part of the strategy because we need to be patient and wait for setups that fit our strategy to emerge. There is NO hurry! After an entry signal, we monitor the trade and plan our exit strategy. After the exit, we study the charts and wait for setups to emerge. Weekly StochRSI(5) is used for the setup stage (first stage).
The next chart goes back to daily bars with RSI(14). A move into the 30-50 zone creates a short-term oversold condition and this is also a setup. During the “setup” period I study the chart for signs of an upward catalyst and/or a short-term bullish continuation pattern that may produce an entry signal. The chart below shows four short-term bullish continuation patterns forming since Fast Stoch turned bullish in late April. Also notice that RSI dipped into the 30-50 zone twice (gray zone).
The monitoring stage starts once a setup moves to a signal and we enter a trade. This is when we plan our exit, which can be a trailing stop, trend reversal signal or profit target. There are more exit options, but these are the basics. It is just important that we plan our exit strategy and then trade according to that plan.
This “Define the Trend and Trade the trend” strategy is pretty straight forward. First, find a trend-following indicator that you like and one that captures trends longer than three months. Second, find a mean-reversion indicator or two to find setups within a bigger uptrend. Third, put these setups in a watch list and wait for a bullish catalyst and/or chart pattern to emerge for a signal. Fourth, monitor price action after the signal and plan your exit strategy. Fifth, exit and wait for the next setups to emerge. And don’t forget to go have a beer once and a while.
Reflections 2020 on SCC-TV
I just recorded a video for Reflections 2020 on StockChartsTV. It will air between December 28th and January 1st, but I am making this available to TrendInvestorPro subscribers today. I cover ETFs related to the Technology and Healthcare sectors using the Full Stochastic for trend signals. We then turn to weekly StochRSI(5) and daily RSI(14) to identify short-term bullish setups within uptrends. I also point out several short-term bullish continuation patterns.