Trading System Basics, Following Momentum

10/15/09 08:47:30 AM

by Donald W. Pendergast, Jr.

Generally speaking, the most reliable, profitable, and long-lasting trading systems are built around one or two proven concepts. Follow along as we seek to create a winning system, using ordinary trading indicators that are combined in an especially effective way.

Security: JOYG
Position: N/A

Most traders have heard the phrase "Follow the trend." They've also heard that they need to "buy low and sell high" or to "buy high and sell higher." Obviously, there's quite a bit of leeway in the correct interpretation of those three sayings, and, in fact, each one of them could provide a sound basis for a winning trading methodology. For now, though, let's attempt to build an effective daily based trading system that agrees with the tenets of "buy high and sell higher." This method of trading is simple, fairly objective, and could produce healthy returns over time, depending on the fundamental quality of the stocks chosen.

FIGURE 1: JOYG, DAILY. It ain't magic, but this particular MetaStock template could be the doorway to steady gains for stock traders with the self-discipline to adhere to its trading logic.

Graphic provided by: MetaStock.

Graphic provided by: CS Scientific Inc. expert from MetaStock v.11.

Figure 1 is a chart of Joy Global, Inc. (JOYG), one of the world's major suppliers of mining equipment. If you have MetaStock v. 11, the following items were used to create this template:

* A 20-day EMA (green line)
* A 50-day EMA (red line)
* A 200-day EMA (blue line)

* An Aroon (14) indicator
* A MetaStock IntelliStop (MS 11 Intellistop Buy [long term])
* A MetaStock CS Scientific expert advisor (horizontal ribbon at bottom of chart)

You'll note a green shaded vertical box has highlighted one particular bar; this was on September 11, 2009, when all of the particular buy signals were generated for a long entry. Here's the logic that underpins this particular template — the first item you'll want to see is a flat to rising 200-day exponential moving average (EMA) where the price bars are also above all three of these key (the 20-, 50-, and 200-day EMA) moving averages. The 20- and 50-day EMAs need to be above the 200-day EMA and the 20-day EMA must also be above the 50-day EMA. In addition, and this is the most critical factor of the entire trade setup, the spread between the 20- and 50-day EMAs must be relatively narrow (the only subjective part of this trading method), with the spread between those two EMAs beginning to widen.

At the same time, you also want to see the Aroon (14) trend intensity indicator complete a bullish crossover (the blue line crossing the red line to the upside) and, if possible, a fresh CS Scientific expert advisor +L+ gray ribbon also having printed at the bottom of the chart. The combined power of the Aroon (14) and CS Scientific expert is a wonder to behold at times and almost guarantees some sort of an upward move in the stock or commodity in question. Adding the triple EMA configuration/confirmation only increases the trend-following effectiveness of the method, and frequently results in a decent, low-risk profit.

On the JOYG trade, the trade entry would have been made the day after the trade setup confirmation, going long at the open ($40.78). Applying the long-term Intellistop provided an initial stop-loss level of $38.43. Trade management would have involved nothing more complicated than adjusting the trailing stop in your brokerage account according to each new Intellistop calculation at the end of each trading session. You can see just how simple and effective this "buy high, sell higher" method worked out; the trade produced a gain of $5.02 per share or about 12.3% in only 10 days (the trade was exited on a break of the Intellistop at $45.80 on September 24, 2009), not a bad deal at all.

Before you rush out and apply this template in your MetaStock v.11 software, be aware of a few other factors that will be critical to the overall effectiveness of this method. First of all, you need to only use stocks that have attractive fundamental characteristics such as steadily increasing earnings estimates, low price/sales ratios, and/or healthy return on equity (ROE) ratios. In addition, you also need to select stocks that hail from industry groups and market sectors that are outperforming the broad market indexes. If you faithfully apply all that has been discussed here, you stand a good chance of making consistently good returns from the stock market over time, despite the occasional bump in the road. Even better, during confirmed bear markets, this method will keep you out of the market altogether, a comforting thought for those who were mauled by the big bad bear during 2007–08.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title:	Writer, market consultant
Company:	Linear Trading Systems LLC
	Jacksonville, FL 32217
Phone # for sales:	904-239-9564
E-mail address:	lineartradingsys@gmail.com
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Trading System Basics, Following Momentum

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