by Tom Aspray
In my market analysis, often an ETF or stocks are not included because there is no favorable risk entry point. A poor entry level generally causes the worst losses whether you are an investor or trader. Even if your buy or sell setup does happen to fail, a good entry point can be the difference between a small and a large loss.
In trading, and teaching technical analysis for three decades, I have also come to realize that each person has to find a method that suits them individually. One of my favorite entry methods is to buy at a Fibonacci retracement level after the weekly and daily analysis have confirmed a low. But some are not comfortable using Fibonacci analysis in their trading.
As I discussed in detail (Profiting From Fibonacci Entries & Exits), establishing a long position as a market corrects to between the 38.3% and 50% support levels is a very good way to obtain a low risk entry level.
Successful investing or trading is all about risk control as taking a 15-20% loss can be disastrous to your portfolio. This type of loss is generally the result of either not calculating the risk before you take a position or not using a hard stop.
In my recommendations, I use a number of different methods to determine both the entry as well as the exit levels. Some are based on the action of indicators but others are not quantified but come through many years of experience (Finding High-Probability Entry Levels).
In this week’s trading lesson, I want to look at how you can use the relationship between price and an exponential moving average with starc bands to determine when the risk is too high to buy or sell.
Often when a stock or ETF is in a solid intermediate-term trend, it can provide a number of good trading opportunities for those who are more active. In my Charts in Play column, I generally try to stay with the intermediate-term trend and therefore do provide shorter-term trading advice. The exception is when a position reaches a high risk level and I will recommend taking a partial profit.
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Trading the same market repeatedly gives you the advantage of becoming very familiar with both the price and volume behavior. One stock I had been watching since the bear market low was Alcoa, Inc. (AA), which had peaked above $40 in 2007.
Though the stock had several rallies since the early 2009 lows, a strong weekly bottom was not completed until last year. The chart shows that AA finally was able to move above its ten month downtrend, line a, on Friday, October 18, 2013. The price action was confirmed by the relative performance as it also overcame its resistance (line b) at the same time.
The volume also supported prices as it started to increase in September with over 200 million shares trading the week of October 11. This was the highest weekly volume in two years. The breaking of the OBV’s major downtrend, line c, suggested bullish accumulation. The OBV was soon in a clear uptrend, line f, and has confirmed each new price high through August 2014.
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Two weeks after the base was completed, AA traded well above its weekly starc+ band for three consecutive weeks. This was a sign that the stock was in a high risk buy area. On the daily chart, in addition to the starc bands and the 20-day EMA (in red) I have included the spread between the closing price and its 20-day EMA. It is expressed as a % of the close and I will refer to it as the EMA Osc.
Just two days after the weekly bottom was confirmed (October 22), AA closed 10% above its 20-day EMA as well as above its daily starc+ band. Those considering the long side would have needed to use a stop under the recent lows, which would have been a risk of approximately 15%.
Over the next two weeks, the upper band was tested several times (circle 1). On November 4, AA made a new daily closing high at $9.92 with the EMA Osc closing at 9%, which still too high a reading to buy.
Just three days later, the EMA Osc had dropped to -2% indicating that AA closed 2% under its 20-day EMA (point a). It traded below its 20-day EMA for eight consecutive days with a low of $8.78. Those who bought when AA was below the 20-day EMA could have used a stop under the low of $8.54. This was the weekly price low of the week when the bottom was confirmed.
By the latter part of November, AA was in a clear new uptrend and by the end of the year was again testing both the weekly and daily starc+ bands (circle 2). The EMA Osc reached a high of 8%, indicating that those who wanted to buy should wait.
Just nine days later, the Osc dropped to -1.5, as AA declined almost a dollar from its high as the daily starc- band (point b) was tested. This decline took the stock below the lows of the prior fourteen days and would have likely stopped out any new long positions.
Alcoa quickly reversed to the upside and during the week ending January 24, the stock hit a high of $12.32. It closed above the daily starc+ band for three days in a row and was also above the weekly starc+ band at $11.89.
The stock was clearly in a high risk buy area as the monthly starc+ band had also been overcome. The bullish signals from the multiple time frame analysis favored buying on a correction. I recommended going 50% long AA at $10.86 and 50% at $10.24 with a stop at $9.88.
The low on February 10 was $10.83 so both buy levels were hit. On that day, AA closed 2% below its 20-day EMA and stayed below if for several days before turning higher. The daily starc+ band was not tested again until April 1 as the EMA Osc reached a high of 6.5%.
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Walt Disney Co. (DIS) has been recommended twice in 2014 and let’s start by looking at the technical action in late 2013 and early 2014. The relative performance was in a strong uptrend (line c) from the late 2012 lows. In early January, DIS hit a high of $76.69 and came very close to its weekly starc+ band (point 1).
This new high was accompanied by an upside breakout in the RS line, which moved through the resistance at line b. The weekly OBV had also made a new high with prices and was already in a solid uptrend. Therefore,a pullback was considered to be a buying opportunity.
As I said at the time:
- DIS peaked early in January at $76.84 and hit a low last week of $71.12, which was a drop of 7.4%. It did close above the quarterly pivot at $72.01.
- The quarterly projected pivot support is at $67.49.
- The insert of the weekly chart shows that DIS has closed lower for the past four weeks and is now close to its 20-week EMA at $70.60.
- A doji was formed last week and a close this Friday above $73.63 will trigger a high close doji buy signal.
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It is important to note that in early February, DIS had also come close to its weekly starc- band and the daily chart shows that the starc- had been tested several times over a three week period. The EMA Osc dropped to a low of -4.55 on February 3, which, so far, has been the lowest reading of the year.
It was recommended as a buy that day as I advised going 50% long Walt Disney Co. (DIS) at $71.44 and 50% at $70.24 with a stop at $68.23 (risk of approx. 3.7%). The following day it traded as low as $69.88.
Three days later, DIS gapped higher in reaction to its strong earnings. The close that week at $75.67 did trigger a weekly HCD buy signal. After seven days on the upside, the EMA Osc had risen to 5% as DIS closed at $79.23. The stock continued to move higher in early March but as it made its high of $83.65 the Osc only rose to 4.7%. This was a sign that the upside momentum was weakening.
At the time, I was turning more cautious on the market so I sold 1/3 of the position at $80.50 and was stopped out of the remaining position at $78.57 for an 11.8% profit.
The correction from the high of $83.65 lasted for over five weeks (see Fig. 3) as DIS was pulling back from its weekly starc+ band. The weekly technical outlook was still clearly positive as the RS line and OBV both made new highs in March.
On April 15, DIS made a low of $76.31 and in that’s week trading lesson I noted that there were signs that the correction could be over. “The weekly chart shows a quite orderly correction from the March high that has taken prices back to the still rising 20-week EMA at $76.24 this week. DIS looks ready to close the week above the quarterly pivot at $77.86 with monthly projected pivot support at $77.02. The uptrend from last September’s low, line e, is now at $74.34.”
The EMA Osc dropped to -3.4% at the early April low and I recommended going 50% long at $78.29 and 50% long at $77.16 with a stop at $74.13 (risk of 4.6%). Six days later, DIS dropped back to a low of $76.88 (point 1) as the EMA Osc reached -1.7%.
DIS has stayed strong every since but we are now holding only 1/3 of the original position. The strong daily uptrend can be compared with the readings of the EMA Osc as short-term peaks have often corresponded to readings of +3.0% as was the case in July, point 2.
On the other hand, pullbacks often dropped the closing price just slightly below the 20-day EMA. On August 7, DIS dropped to a low of $86.17 with the Osc at -0.74 and the stock has since rallied sharply from this low.
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In using the EMA Osc, it is essential that you have confidence in your view of the stock or ETF major trend. The decline in early February was sharp enough to cause many that were planning to buy at the end of 2013 to stay on the sidelines. The low on February 3 was accompanied by a very oversold reading of 3.42 in the ARMS Index (TRIN).
The EMA Osc on the Spyder Trust (SPY) dropped to -3.6% the same day. By the end of the next week it was at 1.9% and by early March it had reached 2% as the SPY closed at $188.26. Those that were considering buying would have needed to use a stop at least under $183.75, which was the March 3 low.
Though on an approximate risk level this was not too bad, the Osc readings suggested it was still high risk. The readings from the EMA Osc can also be used as a momentum tool as when the SPY made a further new high of $189.70 on April 4, the Osc was only at 1.7%.
One can compare the higher highs in price, line a, with the lower lows in the EMA Osc, line b. The correction from the highs was quite sharp as SPY dropped down to its daily starc- band. The Osc had a low of -2.2% suggesting that the risk level had declined significantly.
The rally in late May and early July caught many by surprise and those who decided on June 4 to chase the market may have wanted to know that the close was 2.1% above its 20-day EMA. This meant that it was overextended and SPY was also close to the daily starc+ band.
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