Author: Joe Rabil

Invest Like A Pro! > Articles by: Joe Rabil
Entry Triggers on the Lower Time Frame

Entry Triggers on the Lower Time Frame

Above, is a good framework of what to look for on the entry/trigger time frame (short trade). If MACD crosses down through Signal line on the break of the uptrend line (red trendline), step 1 in a change of trend; then on step 2, it should setup some version of a pinch play which is where the 1st entry arrow is pointing. 2nd entry arrow is the MACD crossing down through the Signal line. Last arrow is the break of the 40 MA line. Entry 2 and 3, at times, will happen simultaneously so it is important to understand the concepts below.

Keep in mind, we do not know 2 is 2 until it turns down. Do not pick a top. Either wait for MACD signal or go down to a lower time frame for the trigger. In addition, the target area is typically based on the swing tops and bottoms on the Trend time frame (Trade-able time frame) which is one time frame above the trigger time frame. I always prefer looking for 3:1 reward to risk or better on my trade setups. Using this approach is a good way to filter out bad entries as discussed below.

When a trigger signal develops, it is important to recognize how many bars down from the peak the stock has moved. Entry on bar 1-2 are best (YES entry example is day 2). Entries after 3-5 bars down (??? entry example) have greater risk to the stop and have greater risk of moving against you first before eventually moving in your favor. This can be very uncomfortable psychologically.

Rules for Multiple Time Frames – Rule 3

Rules for Multiple Time Frames – Rule 3

Rule 3 – The trend and momentum of the higher time frame determines the direction and therefore the action taken on the lower time frame.

Using Apple Inc. (AAPL) from 1990-1991, this daily chart shows three arrows. The first points to where the trend on this time frame turns bearish. In this case, we would be looking at the hourly chart (lower time frame) for shorting opportunities while bearish conditions exist on the daily chart. Then, in the 4th quarter of 1990, the up arrow reflects the change in trend using the crossover and slope of the 18 MA and the 40 MA lines.

During this time, using Rule 3, we would only take buy signals on the hourly chart.

I would like to point out that the slope of these two MA lines were rising at about the same rate, almost parallel, with a comfortable distance between them. These are the characteristics of a strong trend. I will discuss momentum indicators later in the book that will help with this determination. However, having the ability to recognize a strong trend and its momentum using only price and MA lines is a clear advantage when you are trying to decide which higher time frame trends to play.

Our odds increase when the higher time frame trend (daily, in this case) and the trigger time frame (hourly) are in agreement. Finally, the last arrow signals the daily trend reversing to the downside again. At this point, we would be down on the hourly chart looking for high probability sell signals.

The higher time frame tells us there is a trend with good momentum and the pullbacks along the way provide an opportunity to find an entry on the trigger time frame. Your odds of finding winning trades, whether long term or short term, will increase significantly by using this rule. There will be many examples throughout the remainder of this manual of how to put this rule into practice.

Why Technical Analysis is Needed

Why Technical Analysis is Needed

For more than thirty years, I have had the pleasure of working with some of the best portfolio managers in the world. Many of them have been on the cover of Barron’s, The Wall Street Journal or have been interviewed on CNBC. My conclusion is that, with a few exceptions, the best money managers use both fundamentals and technicals together. An investor who has confidence in identifying which stocks to buy and the patience to wait for the technicals to agree with their fundamental conclusions has a distinct advantage over the competition.
I have had many investors, both individual and institutional, tell me that they do not believe in technical analysis. While I am not going to say that using technical analysis is for everyone, I do believe that it will help in most cases. I have watched long term professional investors follow their fundamental models and evaluations without the help of technical analysis and it has hurt their timing and their performance in most cases.

Understanding where a stock is positioned in relation to its long-term trend will help to identify whether a decline in the stock is a buying opportunity or not. The chart above shows the long-term trend (blue). The red bars are examples of a stock declining on this chart where the first would be considered good weakness – a buying chance – while the second is bad weakness – likely something that has more downside risk in the coming weeks or months. Keep in mind, for a shorter-term trader, the long term trend is derived from a daily chart or an hourly chart as opposed to a monthly or weekly. The process of analysis is the same but the time frames change.
After working with some of the best fundamental investors in existence over the past three decades, I have found that their fundamental models can often be early since the stock will pass the screen as price is moving down to their fundamental buy level. The problem is that this drop sometimes coincides with a break of key support and when that occurs the decline can continue to weaken over the next three to six months.
Warren Buffett, one of the great investors of our time, has been successful without the use of technical analysis. However, the average investor must keep in mind that he has deep pockets. He will add to his losers until they turn around. Kraft Heinz Company (KHC) is shown below. This is one of his investments which he has owned for a long time. I am not trying to find flaws in Buffett’s approach. In fact, his long-term performance speaks for itself. Nonetheless, it is important to realize that most investors cannot stomach a 50-75% drop in a stock and have the faith to see it through or keep buying. Most will give up at some point when the severity of the drop gets to be too much to stomach.

Incorporating technical analysis into your approach will help to eliminate this scenario. In fact, this method, when applied correctly should be reflected in small losses when compared to the size of your average gain. The most important factor is that it allows you to define the risk before you buy the stock. Being very diligent about the loss side of the equation and keeping them manageable is probably the most significant factor in your success over the long term.

Rules for Multiple Time Frames – Rule 2

Rules for Multiple Time Frames – Rule 2

Rule 2 – The higher time frames overrule the lower time frames.

Rule 2 means that if we have a buy signal on the daily chart and a sell signal on the weekly chart at the same time, the weekly chart wins.  Exxon Mobil Corp. (XOM) below has a bullish crossover on the daily chart at the same time there is a bearish crossover on the weekly chart.  We do not want to buy this daily signal when it is essentially giving the same signal in the opposite direction on the weekly chart.

Exxon Mobil Corp. (XOM) daily chart with 18 MA crossing above the 40 MA line.
Exxon Mobil Corp. (XOM) weekly chart with 18 MA crossing down below the 40 MA line.

In fact, I will show you the tactics to take advantage of this scenario later in this manual.  For now, just understand that we never take a setup on a lower time frame (daily) if the higher time frame (weekly) is giving an opposing signal at the same time.

2 Time Frame Pinch Play with entry, stop and target.

2 Time Frame Pinch Play with entry, stop and target.

I have provided an example of a short sale signal using the 2 time frame pinch play from my book “Invest Like a Pro”. Risk management is of paramount importance when doing trades of this type. In order to be successful over time, you must be very strict about the loss side of the equation. If you just buy because a stock looks like it is going higher or you sell (short) a stock because it looks like it is going lower, i believe you will struggle to be successful as a trader. By refining your timing, you will improve your reward to risk equation which will increase the odds of success. The 60 minute and 10 minute charts of AT&T (T) below show how to improve your timing and entry as well as reduce your risk in a trade.

60-minute chart higher time frame:

Here is an example of how this approach can be used on two intraday time frames.  Above, we see the 60 min chart triggered on the gap down at the open.  If you shorted at the open you would need to put your stop above the peak from the prior afternoon around $24.70.

10-minute chart lower time frame:

I left the circled area from 60 min on the 10 min chart so we can see the timing of the trigger.  The timing and reward to risk equation improves dramatically by moving down to the 10 minute chart and waiting for a second pinch. Notice how the trigger took place before a big extended move.  That is important when the higher time frame qualifies via a gap.  Target was hit by .04 before turning up. So, by waiting for the lower time frame to provide a more timely trigger and stop, we were able to hit a 3-1 reward to risk target in just a few hours.

Rules for Multiple Time Frames – Rule 1

Rules for Multiple Time Frames – Rule 1

Rule 1 – Every time frame has its own structure as well as support and resistance levels.

A simple way to see price structure is by using the filtered wave theory described earlier.  The waves for each time frame will be different since each wave is trying to closely mimic the key turning points for the specific time frame.  The turning points for these waves are considered important support/resistance levels since they were strong enough to cause a reversal. 

The above chart is the daily of The Hershey Company (HSY) with the wave structure and support and resistance lines.  The red line connects the highs and lows of each wave in the price structure which helps to define the trend.  This shows the price peaked in Feb 2014 at $108.69 and made a lower high followed by a lower low bottoming at $87.88 at the end of July 2014.  Since that time the price waves have made a higher low and a higher high.  The reversal point for each wave is considered support/resistance on that time frame.  As you can see, in this time frame, there are several horizontal lines drawn depicting potential support and resistance levels.

This chart is the weekly of The Hershey Company (HSY) with its wave structure and support/resistance lines.  Notice how much less noise there is on the weekly time frame during 2014.  The daily chart had several waves during 2014 but the weekly only had one top and one bottom.  As a result, we can see that the price structure is unique to each time frame and key support and resistance lines are different as well.  It is important to recognize that key turning points will display differently in each time frame.  In this case, the weekly chart shows the two most important reversal levels of 2014.  This should be factored into any decision when looking the daily chart.  We always want to look up a time frame to see key levels of support and resistance.  In addition, we want to identify the trend based on the wave structure of the higher time frame.  In general, it is best to trade when both time frames are shifting their trend simultaneously, but this happens less frequently.  Instead, we can use key support and resistance lines on the higher time frame to help decide whether the trade has the proper risk/reward characteristics on the lower time.

The Key to Trend Analysis

The Key to Trend Analysis

As I mentioned in my last article, the difference between the 18 moving average and the 20 moving average is very small.  I believe the techniques described on this website and in my videos can be employed by any intermediate term moving average line 18 to 22 periods in length.  If you prefer to use a 20 MA instead of 18 MA, that is fine.  However, stick with it.  Please do not switch back and forth.  Your mind will learn to assimilate to whichever MA lines you choose.  But, if you continue to switch the lines, your subconscious mind will never be of service.  I know from my own experience after using the same MA lines in viewing millions of charts over the years that there are times where I know what is coming (an intuitive feeling) but I have a difficult time explaining it to my clients in the form of hard facts.  This is the subconscious mind taking over and it can be a powerful tool in chart reading.  It will only work after your mind has processed thousands and thousands of charts which have the same look to them. 

Whichever length you choose, this intermediate term moving average is the most important component in this strategy.  While I use the 18 MA and the 40 MA as a buddy system, it is the 18 MA which really drives this approach.  The position of the 18 MA on the monthly chart will play a large role in defining your longer-term investment strategy for a given instrument.  It has the same effect as the wind blowing at your back when riding a bike.  If you have ever tried to ride a bike on open road with the wind in your face, this will give you the sensation of what it is like to make a long-term investment when the 18-month MA is working against you, i.e. bad weakness. There are very few exceptions to this rule.  The monthly chart of Amazon (AMZN) below shows what can take place when the 18-month MA line is working for you.  This line has been rising since 2009 except for a pause in 2014 where it flattened but never turned down.  As long as this MA has good upward slope, the long-term trend is bullish with good momentum.  The slope of this line is important to monitor.  I have bolded the line on the next few charts to show that the 18 MA on each timeframe is the driver for this approach and quite often will be the same as the trendline if it were drawn in.  Also, it tends to

provide support on pullbacks when it is rising and offers resistance on rallies when it is declining.  It is a moving line so it is an area of support/resistance as opposed to an exact level. The monthly chart of Walmart (WMT) is a good example of how the slope of the 18 MA helps to provide a bias for the long-term trend.  Since we are using an 18-month MA, it is considered the long-term trend.  An 18-week MA would be considered the intermediate-term trend.  The first shading on the WMT chart shows a flat period for this MA line and that puts the bigger picture trend in the neutral camp until the breakout in early 2012.  Then, in late 2014, a sharp selloff turned the 18-month MA lower.  There was no

confirming price evidence of a change in trend (explained in the 1-2-3 Change in Trend article). The decline reversed back to the upside after spending significant time shifting the slope of the 18-month MA line back up in early 2017 (second shaded area).  The act of turning this monthly line is time consuming and often provides plenty of time to monitor while this process takes place.  In this example, it took nearly a year to turn from the point that rallied up to it for the first time in 2016. Note that when this line turned higher, it became nice support on two deep pullbacks during 2018.

Simple Ways to Define the Trend

Simple Ways to Define the Trend

The goal of investing is to find low-risk, high reward entries.  Granted, managing and exiting positions are extremely important skills as well.  However, a good entry makes the process much easier.  The first step in this process is to identify the trend of the stock or market you are thinking of buying.  I have touched on the use of moving averages as a way of defining trend.  However, there are many methods to achieve similar feedback. 

I have been influenced by several great traders and teachers, including W.D. Gann, Victor Sperandeo, Linda Raschke, Dave Landry, Kevin Haggerty and Stan Weinstein.  Each of these market professionals agrees that PRICE is the ultimate factor that determines if stock is in an uptrend, downtrend, or transition.

Google Inc (GOOG) Daily

The chart of Google shows price only. It is clear based on this chart that GOOG is currently in an uptrend. The stock is moving from the lower left side of the page to the upper right and it is making higher price peaks and higher price valleys. It is best to keep technical analysis simple.  I have been telling clients for years that PRICE and VOLUME studies are the foundation to good technical analysis.  Before one starts to study indicators, I recommend first becoming an expert on price and volume.

In today’s computerized world, many of the software programs can be programmed to identify price trends assuming one knows how to do it. As described earlier, moving averages work very well for this purpose. I have drawn trendlines on tens of thousands of charts over the years and I still do. However, the proper use of moving averages can save a lot of time in this regard and reduce much of the ambiguity.

Another way of seeing and defining the trend is with the use of swings or waves.  W.D. Gann referred to these reversals as swings.  In the 1970’s, Art Merrill wrote a book about this concept and referred to the changes in direction as filtered waves. Many software programs call this indicator a Zigzag.

Above, the chart of Apple Inc. shows a 4% filtered wave overlaid onto the price chart.  A filtered wave means that all movement which is less than the filter is ignored.  In this case, any pullback of less than 4% does not create a wave.  Notice during 2009 this stock made higher bottoms based on a 4% filter. Using this filtered wave theory (Art Merrill, Filtered Waves- Basic Theory), one can quickly ascertain the direction as well as the longevity of the trend of a given market.

Here is the same time period as the previous chart.  However, this chart of Apple Inc. (AAPL) has our 2 simple moving averages, the 18-day moving average and the 40-day moving average. Notice that in February the 18-day MA crossed over the 40-day MA and remained above for the entire year. This reflects the same positive feedback that we just discussed with a 4% filtered wave. These are two very different approaches to defining a trend, but both are very simple and the resulting signals are virtually identical in this case. 

Why an 18 and a 40 MA? Why not a 20 and a 50 MA? Or exponential moving average?  What about the 200-day MA? (one of the most widely used MA lines). These are valid questions. Using a 20 and 50 instead of 18 and 40 would work fine. Frankly the difference between an 18 MA and a 20 MA is quite negligible. Put both on a chart at the same time and you will see what I mean. I favor the 18 MA simply because the slope shift is a little quicker than the popular 20 MA. In addition, for this method of using 2 moving averages together like a buddy system, I have found the simple MA lines to be more useful then the Exponential version.  Again, it is a personal thing and the use of EMA’s (lines which give more weight to the most recent closes in a sequence rather than weighting them all equally like the simple average) can be employed with success but you will probably need to adjust the length to make the signals a little more comparable. 

In my opinion, moving averages should not be used as an exact science. In fact, technical analysis in general, while having various quantitative benefits, is probably best when not used as an exact science either. The question of the 200-day MA is easy to answer. If we display a weekly chart with 18 and 40 MA’s, the 200-day MA is shown in the form of the 40-week MA. I prefer to use multiple time frames in my analysis because it has proven to be very helpful in refining my stock selection and timing process.  Having the ability to look at each individual time frame and its own structure, price action and momentum is useful information when trying to find key inflection points.  This will become clearer as I give more examples throughout the text.  Also, I will show why I use the 40 MA together with the 18 MA in future articles.

A Chart is a Chart

A Chart is a Chart

The goal of technical analysis, first, is to define the trend.  I will show a few different methods for defining the trend in the coming pages.  There are countless ways to define a trend but, in my view, keeping it as simple as possible should be the number one goal. 

The second goal is to determine the strength of the trend.  The strength of the trend is defined by its momentum.  In other articles, I show a few different ways to determine the strength of a stock’s trend.  The momentum of a stock can be determined by comparing the most recent price legs, or by using momentum indicators such as MACD, ADX or RSI. 

The final goal is to ascertain how long the trend has been in place.  Knowing the length of the trend is vital because the longer a trend lasts, the higher the probability for a significant correction or a reversal to take place. Below is a stock chart.  I have erased the name, dates and time frames from the chart.  This is just a set of open, high, low, close bars and a simple 18 moving average (magenta) along with a simple 40 moving average (blue).  An 18 simple moving average (MA) takes the last 18 closing prices, adds them together and divides by 18.  When plotted each day, we get a smoothed history of the closing prices over time.  A simple 40 moving average (MA) is plotted the same way only using the past 40 closes in the calculation.  Most investors that have read anything about moving averages are familiar with moving average crossover signals.  Simply put, a crossover signal takes place when the 18 MA line crosses above or below the 40 MA line.  These crossovers can be helpful in defining the trend of the stock.  In addition, the slope of these MA lines, rising or falling, and the degree to which they are rising or falling also help with determining the strength of the trend.  Regardless of whether these bars have developed over minutes or years, the pattern should be read the same way.  Identifiable patterns take place whether these bars are hourly, daily, weekly, or monthly.   The three arrows show where a crossover occurs AND the slope of the MA lines are in agreement with the crossover signal.  This is where the trend is defined as positive or negative based on these parameters.

The slope of the moving averages (18 and 40 MA) and the price structure will change if I switch from a daily chart to a weekly chart, but the process of analysis is identical.

When evaluating a stock chart, the investor must know his or her own risk tolerance in order to determine what time frame is suitable.  Generally, the longer the time frame, the larger the initial risk taken in each investment.   However, the degree of accuracy typically improves.  While minor swings may be manipulated at times, the long-term trend cannot be altered.

ADX Conditions That Help in Stock Selection

ADX Conditions That Help in Stock Selection

Looking at weekly MSFT, I have highlighted 2017.  Notice how price trended starting in late 2016 with the 18-week MA line and the 40-week MA line running almost parallel for the entire year.  ADX started turning up in the beginning of 2017 and rose strongly all year long.  When the ADX line is strong enough to get above the 25 (grey line) level, the stock is in trend mode and it is okay to consider looking for entries on the lower time frame.  The very strongest trends will stay above 25 throughout a pullback or correction phase.  Good ADX strength is what we are looking for on the higher time frame.  We want to see stocks make higher highs in price and confirm it with ADX peaks above 25.  This is a great starting point if you want to use a screening tool to identify potential candidates. 

Another key factor is what the stock was doing prior to the trend starting.  If a stock spends a significant amount of time in a quiet basing phase or a sideways consolidation, the ADX/DI lines will all drop under 25.  If this goes on long enough to form a pattern on the price chart such as an ascending triangle or a rectangle, then the likelihood is that the stock is prepping for a big move in one direction or the other.  MSFT in 2016 shows how this condition can form.  The stock moved sideways for 6 months or so and the ADX lines moved down under 25.  There is

some lag between price action and the ADX indicator.  In fact, as I mentioned earlier, the greater the volatility of the price action, the larger the lag.  Investors need to realize this fact and know that nothing is going to give an earlier signal than price itself.  Every indicator is a derivative of price and therefore will usually take more time to provide the same evidence.  This is the main reason I have continued to repeat myself about learning price first before moving on to indicators.  When you understand price, you can anticipate.  In the case of MSFT, there is no need to wait for ADX to climb above 25 before considering it as a buy because the low ADX base told you a move was coming.  You can already clearly see the price has started to trend nearly 3 months before ADX crossed 25.  Still having ADX and MACD to help confirm or refute the price action are invaluable tools in your arsenal.

A few key aspects to note with ADX: 

  • Periods of low volatility and low ADX tend to be the precursor to big moves.  However, it is best to wait for price to breakout from its range or pattern to avoid long periods of consolidation.
  • Stocks with bullish price trends that have strong ADX readings are ones to monitor on pullbacks/corrections.  On the higher time frame, focus on the stocks in uptrends which are confirming the higher high in price with a strong ADX reading greater than 25, preferably greater than 30.
  • During the pullbacks of these strong uptrends, on the lower time frame, focus on the stocks with weak ADX (negative) readings.  I will give examples to explain this in more detail.

I am going to focus on the last two aspects from above to illustrate how I incorporate ADX into my existing methodology.  Keep in mind that you want to use the indicators to provide different insights rather than necessarily confirming one another.  Waiting for confirmation from each indicator creates too much ambiguity to the signals and makes you question what is taking place.  Not to mention, your entry will be very late waiting for every indicator to confirm.

Instead, I use the ADX to help me to determine WHICH stocks to focus on and I use the MACD to help with the timing of the trigger along with price and the MA lines as previously discussed.

All content is Copyright 2019, Invest Like A Pro, LLC.