Trading With the Wave
The important thing is not to stop questioning; curiosity has its own reason for existing.
By Michael
Before we get into the strategy, let’s dive into the Stochastic RSI which we haven’t discussed yet.
Stochastic RSI
The Stochastic RSI (StochRSI) is an indicator that ranges between zero and 100 and is created by applying the Stochastic oscillator formula to a set of RSI values rather than to standard price data. For all you math nerds out there, think of it as the 2nd derivative of price action and RSI.
What’s important about the StochRSI is that it is only useful when the trend is strong in one direction. In the FB chart below, notice how the EMAs have no order and the overall price direction is sideways, vitually untradeable on the daily chart. Yet, the StochRSI gives us both oversold and overbought conditions constantly.
“Moving averages are smooth lines which overlay a stock chart. They are a lagging indicator which tells us where price has been in the past.”
Compare the FB chart to that of the PTON chart below where the trend is clear and the MAs are in numerical order:
Chart Setup:
- Daily Chart
- 13-Day EMA
- 21-Day EMA
- 34-Day EMA
- 55-Day EMA
- 200-Day SMA
- Stochastic RSI
The Strategy:
Trading an uptrend can be one of the most beneficially strategies in trading an investing. One thing I can promise you is that more money was lost “waiting for a crash” than investing in good companies who have uptrends which last years.
The goal here is to find ideal entries during strong uptrends in strong markets. These entries can be used for long-term investments, options trades, and even day trades.
How do you determine what is a good uptrend? The simplest way to see if an equity is in a strong uptrend is the order of the Mas. In our setup we use the 13, 21, 34, and 55 EMA as well as the 200 SMA. If the uptrend is strong, then these will likely be in numerical order with the 13 on top and 200 on bottom. Additionally, price is ideally above the 55-EMA. Another options for seeing long trends is to zoom out to a 2-Day, 3-Day, or Weekly chart to eliminate some of the outliers.
Now that we have our charts setup and have found a strong uptrend, we want to wait for a pullback and an oversold StochRSI. The pullback most hold the support of the EMAs. The most ideal buy zone is around the 21-34 EMA zone.
Now that price has pulled back and the StochRSI is oversold, we want to see some type of support confirmation or momentum change such as sideways or U-shaped movement.
This is our buy signal.
The 10-Step Congruence Checklist to Buying the Dip:
- Price in Uptrend
- 12 EMA > 12 EMA > 21 EMA > 34 EMA > 55 EMA > 200 SMA
- Pullback to EMA Support
- StochRSI Oversold
- Fibonacci Retracement Levels
- Key Support Levels
- Support Confirmation
- Low Relative Volume Pullback
- Market Uptrend
- Good Company
We have already discussed the first 4 items on the list. The next 6 are “bonuses” to increase our conviction in a trade.
Fibonacci Retracement Levels
Fibonacci retracement levels are horizontal lines that indicate where support and resistance are likely to occur. They are based on Fibonacci numbers. Each level is associated with a percentage. The percentage is how much of a prior move the price has retraced. The Fibonacci retracement levels are 23.6%, 38.2%, 61.8%, and 78.6%. While not officially a Fibonacci ratio, 50% is also used. However, the key levels of interest to use are between the 38.2% and 61.8%.
These key Fibonacci Retracement Levels often line up with our EMA pullbacks and oversold StochRSI readings as shown below:
Key Support Levels
Remembers from the Support & Resistance Lesson, Prior Resistance = Future Support. That rings true especially during strong uptrends.
Support Confirmation
Identifying some form of support confirmation decreases our chances of trying to catch a falling knife, mitigating our risk.
The simplest form of support confirmation is sideway or “U-Shaped” price movement at key support levels such as Fibonacci Levels, prior support or resistance, or EMAs.
The JPM example below shows 4 days of sideways action at prior resistance, 61.8% Fibonacci Level, and the 34-EMA. This is a good indication of a new support level.
Another possible form of support confirmation is a hammer candle at support with a bullish follow through candle the following day as shown below.
Market Uptrend
Trading in an a bullish market is much easier than trading in a bearish or volatile market. Therefore, it is important to take note of the overall market health.
To gain a good understanding of the market, the S&P 500 is a good barometer. Therefore, we follow the S&P 500 Index, SPY, to understand the health.
Additionally, we can follow industry ETFs to understand the health of that sector. For instance, if we wanted to trade JPM (JP Morgan Bank) it would be helpful to check in on the XLF (Financial Index ETF).
Sector rotation is real and is often how the SPY can trend upward for so long. Due to different sectors running and selling off at the same time.
Here is a list of ETFs to follow to give you an advantage:
SPY: S&P 500 (Overall Market)
QQQ: NASDAQ
DIA: Dow Jones Industrial Average (Value)
ARKK: Growth Innovation ETF
XLF: Financials
XLP: Staples
XLE: Energy
XLU: Utilities
XLB: Materials
XLI: Industrials
XLY: Discretionary
XLC: Telecom
XLV: Health Care
XLK: Tech
Good Companies
Trading good companies will always be easier than trading bad companies. Good companies look different to each person depending on risk. Some may view growth with high P/E’s as good companies such as ROKU & SQ while someone else may view them as risky and prefer solid value but less risky companies such as KO and AAPL.
An intriguing company may have increasing growth, strong cash position, a visionary CEO, or a strong product, service or brand.
Summary
- The Trend (Current) must be in your direction
- If we are trading bullish, then
- 12 EMA > 21 EMA > 34 EMA > 55 EMA > 200 SMA
- Price > 55 EMA
- The further away price gets from the 200-Day SMA the riskier trading becomes
Buy Signal:
Price pulls back to EMA support & the StochRSI indicates oversold.
