Your 200-day moving average may show a prevailing uptrend, but consider zooming in with a different perspective to refine your entries and exits.
Visit almost any Southern California beach in the early morning hours and you’re likely to see group after group of surfers paddling out in search of the perfect wave. The quest is never a straight line. As they push to get past the breakwater, small waves temporarily stall their progress, but as long as their strength holds up, they’ll continue to move forward.
Many traders believe markets exhibit similar behavior, yet they don’t realize that stocks move in multiple time frames, so they usually only focus on the most immediate one. By understanding how these different time frames work together, you’ll find a whole new world of potential trading opportunities.
Everyone knows “the trend is your friend,” but trends happen in different time frames. The primary or long-term trend is always the strongest. The goal, then, is to first identify the primary trend and then take advantage of short-term and intermediate-term trends within the overall trend.
Some say a good place to start is to plot a 200-day moving average (MA). The 200-day moving average is the standard long-term average, and many institutions will only buy stocks that are trading above it. In figure 1 we see a long-term chart with a 200-day moving average that is sloping upward and has provided support to the trend at numerous points. Now let’s zoom in on the shaded area.
FIGURE 1: 200-DAY MOVING AVERAGE.
This chart shows a stock that’s trading above its 200-day moving average. Image source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.
In figure 2 we’ve add the short-term 20-day moving average, which is more responsive to price movement. The green arrows indicate entry points when price moves above the indicator, and the red arrows exit points when price closes below it.
FIGURE 2: TWO TIME FRAMES.
This chart includes a 200-day MA and a 20-day MA. Image source: the TD Ameritrade thinkorswim platform. For illustrative purposes only. Past performance does not guarantee future results.
Using the short-term moving average here allows trading with the primary trend but attempts to avoid drawdowns within that trend.
Another way to try to take advantage of the different trends within time frames is look at a chart using different periods. The chart in figure 3 is daily, where once again, the 200-day moving average shows a strong primary uptrend. Now let’s zoom into the shaded area, but this time, using a different time frame—the one-hour period.
FIGURE 3: STANDARD MA.
This chart shows another 200-day moving average with a strong primary uptrend. Image source: the TD Ameritrade thinkorswim platform. For illustrative purposes only. Past performance does not guarantee future results.
In figure 4 you can see that the stock is experiencing a pullback within the primary trend, as indicated by the two red lines forming a downward channel. Because this is an intraday chart, there may be a better way to fine-tune entry when the short-term trend changes and resumes movement in the direction of the primary trend.
FIGURE 4: HOURLY CHART.
Trends within a one-hour chart may look different from a longer-term perspective, allowing you to refine your strategy. Image source: the TD Ameritrade thinkorswim platform. For illustrative purposes only. Past performance does not guarantee future results.
A return to the primary trend is indicated by a price break above the top channel line (see the first green arrow above). A second opportunity (shown by the second green arrow) presents itself when the breakout retests, and “kisses,” the top side of that channel line before resuming the move upward.
Although you would see a similar pattern if you stuck with the daily chart, not having this more accurate view on the shorter time frame might cause some traders to enter too early and get shaken out, or enter late and miss a good chunk of the move.
As with most things in trading, having more information helps traders decide how confident they are in their views. And the more aware you are of how a stock has moved in its respective time frames, the better you will be at deciding where you think the stock will go next.
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