Adding indicators

Posted by Scriptaty | 12:59 AM

In this instance there was an opening gap up, which is more often than not a signal of a move worth jumping on. A gap is an old-fashioned pattern and you could use it without Bollinger Bands, but together the two tools reinforce each other.

Now let’s add another indicator, the moving average crossover. The arrows show where a 10-day SMA crosses above (uptrend), then below (downtrend), a 20-day SMA. Moving averages lag price action, but when used with other indicators, they are a back-up confirmation of raw direction. In the instance of the opening-gap pattern, the moving average crossover was already signaling an uptrend was in place.

We can make moving averages more responsive to price developments by using the moving average convergence divergence (MACD) indicator, which measures the difference between a 12-day exponential moving average (EMA) and a 26-day; a nine-day EMA is then applied to the difference, resulting in two lines — a main indicator line and a nine-day “signal” line. The MACD indicator incorporates a form of momentum: When the slope of the indicator line is steep, the trend has moxie; when it’s flat, the trend has lost steam.

Now notice that the signal line crossed above the indicator line around the same time the moving average crossover occurred. Both these events occurred a few days before the opening gap and Bollinger Band breakout. Golly, how many hints and suggestions do you need before you feel confident enough to take this trade? It’s a no-brainer.

We can use the same indicators on the short side, too.

Notice the MACD gave more than a week of advance warning the moving average crossover was coming — and price itself fell through the 20- day SMA immediately afterward. This time we anticipate the price hitting and breaking the bottom Bollinger Bands, as it does.