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TECHNICAL ANALYSIS


Know The Trend, Know The Trade (Part 2)

06/16/10 08:40:24 AM
by Alan R. Northam

By knowing the high-probability direction of the market, we know how to trade it.

Security:   TWM
Position:   N/A

In a previous article entitled "Know the Trend, Know The Trade," I showed a monthly bar chart of the ProShares UltraShort Russell 2000 exchange traded fund (ETF) and explained why I believed that this ETF is putting in a bottom. Now, I switch to the daily bar chart to see more detail in the trading habit of this security (Figure 1). Note that I have shown the same narrow trading channel discussed in the previous article for reference.

First of all, price remains below the 200-day exponential moving average (EMA). As long as price remains below this average, this security is considered to be in a long-term downtrend. However, the distance between the 200-day EMA and the price bars is narrowing. This is an indication that the downward price momentum of the trend is slowing. Price momentum normally slows before a trend reversal occurs and is a predictor of a reversal in trend.

FIGURE 1: TWM, DAILY. This chart shows narrow trading channel and exponential moving averages.
Graphic provided by: MetaStock.
 
Next, note the three crossings of the price bar above the 50-day EMA (see blue ovals). During the first crossing, this security closed above the 50-day EMA for six sessions before turning back down. During the second crossing, the price closed above the 50-day EMA for eight sessions. Further, during the most recent crossing, the price has remained above the 50-day EMA line for 15 trading sessions. With each crossing, the time spent above the 50-day EMA line has increased. This is significant, as it shows that a change in trend is developing.

Next, price bounced off the lower edge of the narrow downsloping trading channel in late April and has been moving upward since. More recently, however, price moved up to the upper edge of the narrow trading channel but failed to break out and close above it. Instead, price bounced off the upper edge of the trading channel and turned back down. Price has now moved back down to the 50-day EMA. It will be interesting to learn if price will now bounce back upward from off the 50-day EMA or break down below it and continue to trade lower.

To help us determine if price will respect the 50-day EMA and turn back upward or break down below it and continue to trade lower; note that the 20-day EMA has now crossed above the 50-day EMA. This is a significant change of events, as this is the first time that the 20-day EMA has been above the 50-day EMA in more than a year. This is an indication that the shorter-term trend has now turned up. With the shorter-term trend now pointing higher, it further suggests that price should soon turn back upward and break out of its downsloping narrow trading channel.

By looking at the daily time frame of the ProShares UltraShort Russell 2000 ETF, the evidence continues to mount that it is time for price to break out of the narrow trading channel in the upward direction. However, nothing is guaranteed in technical analysis. All that can be done is to determine the probability of what should occur. Therefore, we should expect to see a breakout, but we would not be surprised if the market turns lower once again. A breakout of both the trading channel and the 200-day EMA is still necessary to reverse the major trend of this security from down to up. By knowing that there is a high probability that this security is in the process of reversing its major trend from down to up, we know that now is not the time to be taking trades in the downward direction. However, it may be a little early to be taking trades in the upward direction as well. By knowing the trend, we know how to trade.



Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.

Garland, Tx
Website: www.tradersclassroom.com
E-mail address: inquiry@tradersclassroom.com

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