How to Identify the Soundest Trades

 | Dec 23, 2012 | 10:00 AM EST  | Comments
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Stock quotes in this article:

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Some trades seem to just play out with ease, and with others it may be a struggle or a major battle. The types of trade setups that I identify every day have a higher probability for success than just a coin-flip. But if I were asked to define the characteristics of the highest-probability setups, I could actually explain how to choose those that are 70% accurate, perhaps, rather than 60%.

Let's take a look at a few things that will put these odds on your side.

  1. Time and price confluence
  2. Pattern and trend
  3. Moving averages
  4. Time-frame confluence
  5. Trigger entries

For this article, I am going to focus on how the moving averages can help you.

Remember when Apple (AAPL) used to be an easy trade on the buy side? Buying the dips used to work a high percentage of the time -- and then, everything changed. The stock was shifting gears, and I'm going to use the moving averages to show you why.

On all of my daily charts, I use 200- and 50-day simple moving averages, as well as the five- and 13-day exponential moving averages. On the daily chart, most market technicians watch the 200-day and 50-day SMAs in order to assess the general price trend. If you're looking to buy a stock and the price is above both of these lines, odds more in your favor. If it's clearly below these lines, you're better off looking at the sell-side setups.

Of course, there are times when I see high-probability setups that are not in agreement with this. However, that's only the case when quite a few other Fibonacci time/price parameters are present as well.

Here are the basics on how you can use these averages: Via the daily charts only, when the current price of the stock is above both the 200- and 50-day SMAs, you would look at the buy side of a stock when the five-bar EMA crosses above the 13-bar EMA. Continue to trade the stock from the buy side until the five-bar line crosses back below the 13-bar.

Conversely, if the current price of the stock is below both the 200- and 50-day lines, look to short it when the five-bar EMA goes below the 13-bar line. Continue to trade this stock from the short side until the five-bar crosses back above.

(Also, keep in mind that I only use the five- and 13-day EMA combination on the daily and weekly charts. It's when I'm seeking trade triggers on the intraday charts that I like to use the eight- and 34-day lines.)

Personally, I do not take trades on moving-average indicators by themselves. My trading plan says that l don't enter a stock without my Fibonacci price parameters -- but I do know the odds are with me if these conditions are intact along with one of my setups!

Apple (AAPL) -- Daily
Source: Dynamic Trader

On the Apple chart, note the two areas where the price remained above both the 50- and 200-day SMA, and where the five-bar EMA then crossed above the 13-bar. These would have been a pretty good buy signals by themselves. Also of note: In late September, when the five-day line crossed below the 13-day, that was a warning that the next support decisions might not hold.

Bottom line: Not all my trade setups will have these averages in the right positions, but when they do, it tells me I've got some good odds on my side for the trade to work. Check it out for yourself -- overlay these averages on some daily charts and see how this played out in the past.

Happy Holidays!

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