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MOVING AVERAGES


A Simple Short-Term Entry Strategy

12/21/04 04:10:07 PM
by David Penn

Legendary trader Marty Schwarz swore by the 10-day EMA. Here's an application of his "red light/green light" approach on an intraday basis.

Security:   ESH5
Position:   N/A

A few years ago in Technical Analysis of STOCKS & COMMODITIES, trader Dave Landry proposed something he called the 2/20 EMA setup. Essentially, Landry's approach suggested that if a trader spots two bars or candlesticks clearly above an uptrending 20-day exponential moving average (EMA), a long entry above that pair of bars or candlesticks is often a profitable short-term swing trade.

Landry considered his setup to be just another tool that technical traders could use to help them enter the market. While my experience with this setup is hardly comprehensive, I found the 20-day EMA not to be as effective in this role as I had hoped. Instead--after a long time of looking at other swing entry setups (including my current favorite, a moving average convergence/divergence histogram [MACDH]-based one)--I found myself coming back to Landry's setup. Only this time, I focused on intraday time frames (especially 10 minutes and under, where my MACDH-based entry setup has been less effective). In addition, I substituted a 10-bar exponential moving average for Landry's 20-bar EMA.

Figure 1: S&P 500 emini. There are two instances of the 2/10 EMA setup in this 10-minute chart of the March emini S&P 500 futures contract. Both setups reached their two-point minimums in short order, without once dropping below the entry price.
Graphic provided by: Prophet Financial, Inc.
 
So how does the setup work? Consider this 10-minute chart of the March Standard & Poor's 500 emini futures contract. The 10-bar EMA (in red) is moving sideways, but starts to lift up and separate from the 50-bar EMA (in blue) in the 8:00 am hour (Pacific time). Between 8:30 and 8:50 am, we get two bars free and clear above the 10-bar EMA. That provides the buy signal.

Where is the entry? Try taking the range of the two bars combined (the highest high and lowest low of the pair), dividing that amount in half and adding it to the value at the highest high of the pair. In this case, the highest high was at 1201.25 and the range was 1. Adding half the range to the high provided for an entry at 1201.75. That entry was triggered with the sharp upmove in the 10 minutes between 8:50 and 9 am. An alternate approach--especially if one of the bars in the pair is especially large--is to simply use half the range of the larger of the two bars.


Shooting for two points per contract is a reasonable goal as far as I'm concerned (two points per contract per trading day adds up quite nicely if a trader can be consistent). That gave me a target of about 1203.75. That target was almost reached immediately, as the 8:50-9 am bar rallied to as high as 1203.50 before pulling back to close at 1203. The emini moved sideways for nearly another hour, but never fell below the original entry price. ESH5 fell as low as 1201.50 at one point. Yet approximately one hour after the 8:50-9:00 am rally, ESH5 shot up again, rallying as high as 1204.75 before closing at 1204.25.

Having reached the price target, a trader could then decide how best to manage the trade. Selling the whole position would be one reasonable tack, as would a trailing-the-lows stop (this latter approach would have likely made less money in this specific case). A trader who had done either of those two approaches, however, would have been primed for reentering the market shortly thereafter. The 10-bar EMA penetration of the 10:40-10:50 bar would set the stage for a fresh pair in the 20 minutes immediately following. In this case, we'll use half the range of the larger of the two bars in the 2/10 EMA pair, which gives an entry at 1206.25. With the pair completed at 11:20 am, the entry would have been triggered within the next 10 minutes. Twenty minutes later, the ESH5 had ticked 1208.50.



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Comments

Date: 12/28/04Rank: 2Comment: Great if there is a trending day; tough if there is a ranging (sideways) day. Try explaining this system under ranging situations instead...
Date: 12/28/04Rank: 5Comment: 
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