Our Trading Secret
Wanna know a really good trading technique? Buy when the 6-TEMA crosses above the 20-EMA, as long as the 20 and 50-SMA are sloped higher and are underneath the current price. Easy-Peasy? Alrighty then, this article was short.
Wait, you didn’t get all that? Well, let’s unwrap it a bit more then. Maybe it's not as easy as it sounds, but we'll make it easy in the end.
First, we at Wanderer rely heavily on moving averages for our trading signals. A moving average is a backward looking indicator that shows the average price over the past specified time frame. For example, the twenty-day moving average is the average price of the past twenty days. There is no emphasis on one day over another, as long as they are in the most recent twenty days.
Depending on our time frame, we focus primarily on the 20, 50, and 200-SMA. The S in SMA stands for SIMPLE moving average. To find out what the 50-DMA is, I could take the closing prices of the past 50 days, add them all up, and divide by fifty. OR, I could simply check the box for the 50 DMA and have the charting software calculate it for me and even draw a nice line for me.
There are a variety of different types of moving averages, from simple, exponential, triple exponential, displaced, and more. It isn’t important to fully understand all of them. They are intended to provide the same information. Namely, is the stock trending up or down. A rising moving average means the trend is higher, and of course, a falling moving average means the price is trending lower.
To state the obvious, what the trend is depends on the time frame being looked at. A stock can simultaneously be in a long-term uptrend, medium-term downtrend, and short-term uptrend. Or it can be in an uptrend or downtrend in all three time frames at the same time.
Long-term traders, those that only make a few adjustments to their portfolio per year will be primarily interested in the 50- and the 200-day moving averages.
Medium-term traders—those that make adjustments on a monthly basis—will be primarily interested in the 20- and 50-DMA.
Here at Wanderer, we love trading. While the daily swings of the market give some folks indigestion, we see opportunity in short-term price swings. But how do we know if a short-term move is likely to be big enough to be worth trading? For that, we depend heavily on the Wanderer Financial Indicator, or WFI.
The WFI looks for changes in a stock's price momentum from one direction to the other. To do that, we use a very short-term trading average, usually the 6-day triple-exponential moving average, and combine it with a slightly longer term moving average (typically the 20-day exponential moving average). You can experiment with the moving average time frames, and no doubt traders have, but we find the 6-TEMA and the 20-EMA to be particularly useful for us.
First, the 20-EMA. The difference between an SMA and an EMA is simple vs exponential. In a simple moving average, each time period has equal emphasis. In an exponential moving average, the average is weighted towards the most recent data inputs. A triple exponential moving average really speeds things up so that the average is very close to the current price.
By taking a very short term moving average (the 6-TEMA) and combining it with another, slightly longer moving average (the 20-EMA) we get to see trend changes very early in their development. Let’s see how this works in practice.
Whenever we take a position in a trade, we always want as many things working in our favor as possible. In the chart below, we can see how this plays out. As the SPX approached this upper trendline resistance, notice how it curled back down and sold off each time. Each time it rolled over and headed downward, it made the resistance line that much stronger. With a clear area of resistance so obvious on the chart, we watched carefully for signs that the price would be able to rise above this congestion level.
Now if we look at the same chart, with added commentary, notice where we marked the price broke through resistance. We then waited for a retest of resistance, and when the price printed a sell signal which was immediately reversed into a buy signal, we also noticed the price managed to rally back above the rising 20-DMA and was also above the rising 50-DMA. We could have only relied on the fact that the price is above a rising 20-DMA, or above resistance, or printed a fresh buy signal, but when you add all three together, you have a high probablity trade. In this case, we would look for individual setups to trade, since we don’t trade the indexes directly.
We zoomed in on the chart below to show how finding an individual stock works with using the WFI on the major indexes and with an individual stock. We think of the buy signal on the indexes as a sort of tail wind, which will help our long positions. Notice on ADBE that it corrected for three months before printing a buy signal and rallying above its moving averages. On its own, it would suggest a decent trade, but when combined with a break out in the major indexes, it becomes a higher probability trade.
Take a look at a similar setup in AMD. Again, there was a prolonged correction, followed by a buy signal and rally above the moving averages. By combining a bull market with the WFI, we are able to catch the bulk of a move. Keep in mind, that not every signal is a buy or a sell. We want the moving averages to be nearby and supportive of the price we are predicting.
Now let’s look at some individual setups to see the WFI in practice. On the chart below, TLT was in a rising trend, before consolidating sideways and issuing a cluster of buy and sell signals. After trending sideways for long enough, it resumed its uptrend. Now let’s look at the signals and see how they worked out. First, we can see that there is three buy and three sell signals. Does that mean we bought and sold three different times? No. If you look closely, the first couple of signals had resistance just on the other side of the price. When the sell signals were flashing, the 50-DMA was just below the price as support, and when the buy signals printed, the 20-DMA was serving as resistance. It wasn’t until the third buy signal that the price was able to rise above resistance, and begin its next trending move.
Moving on to another example. One thing we love to trade is when the price goes sideways to slightly down as a major moving average catches up to the price. Then, the price can explode off of the MA, printing a new buy signal along the way. The chart of FEYE below shows an example of this in play. Notice on the left side of the chart, There was a strong rally from below to above the moving averages in conjunction with a buy signal. Sometimes, the signal will be off by a day or two, as in this case when it printed a buy signal, but didn’t really begin to perform until a few days later.
Now look at the second buy signal. Notice how the price drifted sideways to lower while it waited for the rising 50-DMA to catch up. Once the 50-DMA came into play, the price rode along the moving average, before rallying and printing another buy signal. Catching these buy signals just as they print bullish chart patterns is a low risk way to benefit from a stock that is just beginning to trend. No doubt, you will run across some false signals. But when that happens, the sell signal will usually follow shortly afterward, alerting you to the fact.
We made adding the WFI to your charts easy. Just follow the instructions here: Wanderer Financial Trade Indicator. It's ready to trade right out of the box. Test it out and see how it looks on your favorite stocks.
Note: The Wanderer Financial Indicator is for use ONLY on Daily charts, not on shorter time period candles.