Using technical analysis to identify entry points
By applying two moving averages we can quickly identify the trend and trend change without guessing or drawing a ton of lines and creating a messy chart.
Using Tesla as an example we can see clearly that the trend is up while the 21 EMA is above the 89 EMA (EMA -Exponential Moving Average: An Exponential Moving Average is calculated by applying a percentage of today’s closing price to yesterday’s moving average value. Exponential moving averages place more weight on recent prices, reacting faster to current price changes than Simple Moving Averages).
The 21 crossed above 89 in April 2020 signalling a change in trend from down to up. This helps us identify an initial entry point and so long as the 21 remains above the 89 we can add into the trend after retracements.
There is an 8 ema added to the chart below, showing us that the short-term trend has changed from down to up giving an opportunity to add in or enter for the first time, in the direction of the larger trend. You can create your own ema numbers to suit your time horizon. The shorter the moving average periods the quicker the cross overs (trend changes) happen and vice versa.
If we are using trend lines or other support/resistance ideas, the long-term trend can help determine which direction you want to trade. Below we can see a triangle formation (in Orange) with a risk reward setting of 1:2. We could enter on a close above the upper triangle trend line or a break above the resistance at the high of the triangle to enter in the direction of the longer-term trend.
The trend helps identify direction and whichever trigger system we are using will trigger the entry. It always feels better to be in the correct direction than trying to trade counter trend all the time.
New traders seem to always feel that they need to pick the exact turning point to make money. Now that is a unicorn idea. It will seldom work out that a trader gets the exact low as a buy point. This practice wastes a lot of time and energy. What really needs to happen is that price changes momentum and we have a way to measure that change in order to decide which direction we want to be trading, then we can just wait for the trigger to occur. If a trade captures fifty percent of the total move, it can be considered a good trade.
Exits: The toughest part of any trade is identifying an exit strategy!
In the previous example we could use the low of the triangle as the initial stop loss level and have a straight 1:2 risk: reward plan and the exit would have triggered when the reward level was hit. Another way to decide on the exit would be a stop that follows price higher i.e. a trailing stop loss.
Stop loss (SL) 1 is set at the triangle low once price triggers the buy signal, either the orange trend line or the blue resistance level. Price continued to move higher until a small retracement occurred, the orange resistance level was broken and once that happened the stop could be moved up to SL 2. The Price went through the target of 2x reward, this should focus us on an exit plan, in the example above I just used one of the gaps as a stop loss level(at this point any exit could have been used as the reward target was reached) the idea that an exit can be triggered for any reason can be applied here but the big thing was if the exit was paused to wait and see what happens, that decision would also be valid. Essentially the decision can be made on the assumption that any price consolidation can be used to trigger a stop loss if price breaks the low of the consolidation or another buy entry if price breaks above the consolidation could be applied in this case price broke the lows and triggered the ultimate stop loss and the trade was closed. Now we can go back to the 8ema crossing above the 21 ema so long as 21 is above 89 to trigger another buy and we then rinse and repeat the process.
Take the time read the above a few times while looking at the chart to get clarity if you do not understand it the first time.
In my next instalment I will discuss CFD’s on shares as well as position sizing options for both styles.