Favourable Environments and Trading Rules

There are two situations that are conducive for trend trading.

The first type is when the three moving averages cross over at the same time (I call it a triple cross), or close to each other. Referring to the crossover on the right of the images above, we see that the three moving averages cross over at a point, preceding a nice smooth downtrend in both cases.

In contrast, the first crossover in the first image above occurred at three points (A, B and C). The stock failed to trend after the crossover.

Another good setup occurs when there was a good prior trend (uptrend in both examples above), followed by a pullback to the mid-term moving average (blue). Notice how the short term moving average (brown) almost touched the mid-term moving average in both cases, before turning up again to resume the prior trend.

If I can focus on both types of setups, entering a trade after I see a Type A or Type B setup, I can probably avoid more bad trades.

As mentioned in the previous post, here are some additional pointers to bear in mind:

• Enter only when all 3 moving averages are sloping in the correct direction and in the correct order

• After a triple cross or after a flattening moving average starts to trend again, only take the first 3 setups. Anything more can be overextended.

• A good trend tends to have more trend bars, or one sided wicks. Prefer to have a relatively high proportion of trend bars before the pullback, but trend bar should not be too large, as the move may be overdone.

I will likely miss some good trades, but is catching those trades worth it if the cost is I have to make many bad trades to catch one such good trade? How can I test this? Am feeling lazy at the moment, since I did not sleep well yesterday. Perhaps, one day, I will grade the different trades and determine if it is better to just stick to the above two setups.

Note to self: Always look at the price action on the left of the current bar (perhaps the past 3 months or so). Is this a calm sea that I am competent enough to swim in?

• Ask: Are the moving averages in the correct order and sloping in the correct direction?
• Ask: What stage is this? If you can’t identify the stage, it is probably too choppy.

What would help for me is to definitely prepare a book of model ‘setups’, just like how we memorized model answers in school. Wait for these model setups to appear before taking the trade. But then again, trying to define what is a good setup can lead to rigid decisions. Sometimes, the subconscious mind picks up something that the conscious mind can’t articulate or define.

Summary of Rules

1. Enter only when all 3 moving averages (EMA 15, EMA 50, EMA 150) are sloping in the correct direction and in the correct order.
2. After a triple cross (i.e. the 3 moving averages cross in the correct direction) or after a flattening moving average starts to trend again, only take the first 3 setups. Anything more can be overextended.
3. Ask: What stage is this? If you can’t identify the stage, it is probably too choppy.
4. If the prior 2 trades are losers and exit in less than 11 days, reduce the lot size by 0.1 unit, subject to a minimum lot size of 0.25 unit.