Emini Trading Strategy

Transcription

1 Emini Trading Strategy The following comments are meant as a starting point for developing an emini trading strategy. I m sure things will be added over time. But this is what I have so far. I begin with a discussion of the various charts and indicators we re using. I. Chart Components. A. Renko. The Renko charts provide a basic framework for our strategy. We can think of it as a picture frame in which everything else occurs. And for the eminis, the one-minute Renko chart combined with Ichimoku and MACD provide this frame. The problem with Renko is it s instability. Using an ATR of 14% may be the optimum setting, but this can also cause the charts to fluctuate at times. As price changes in real time, Renko bricks can appear and disappear. This instability can also cause changes to the placement of the Tenkan-Sen lines, which is the key element within Ichimoku that we are using. Due to this instability, we cannot use Renko as a stand-alone chart for trading the eminis. That said, it does provide some significant benefits. Those benefits include: confirming the trend we see on a regular chart, helping us to stay patient with a trade when price is going through a period of consolidation, and giving us some absolutes as trading

2 boundaries. Below is a one minute example of SPY on a Renko chart: Chart # 1 In Chart # 1, the key elements are (1) the Renko bricks crossing the Tenkan-Sen (blue line) and (2) the MACD line crossovers. Although this cannot be coded, this set-up of the Renko one-minute charts should be on one of your screens whenever you are trading the eminis. Obviously, you would choose the correct underlying entity for whichever emini you were trading. SPY works for the ES. QQQ works for the NQ. While these elements work well for framing our strategy and for the other benefits mentioned, we will look to other charts for our actual entries and exits. The reason for this is that the above chart is lagging. A lot of price movement has already occurred by

3 the time we get to these actual Renko crossovers. So, when you see the Renko oneminute MACD lines leveling off after a nice move (the curve in the S-curve), then we know it s time to be looking at our other charts for possible entries and exits. If we wait for the actual Renko MACD line crossovers or the actual bricks crossing the Tenkan-Sen, then we have usually waited too long. But if we haven t already taken action, then these crossovers act as absolutes to let us know that immediate action on the trade is required. Again, Renko acts as the frame for our strategy. And we don t want to deviate from these absolutes. B. Heiken-Ashi Candles and Bollinger Bands I use the standard settings for Bollinger Bands. I flip between the one minute and five minute Bollinger Bands, as you ll notice in this text. Here s a chart sample of the Heiken-Ashi Candles with their Bollinger Bands: Chart # 2 Let me cover the basic elements on the above chart and then talk about how we ll use this chart. Chart # 2 shows a five minute Heiken-Ashi candle chart. To this chart, I ve added Bollinger Bands and Ichimoku s Tenkan-Sen. (I ve eliminated all other elements of Ichimoku for this chart.) I ve also added the Pivot Points to this chart (the dashed yellow line) and the previous day s closing price (the solid yellow line). Chart # 2 shows a pink arrow that points to the midline of the Bollinger Bands. You can see how price is dropping below that line on this chart. For the most part, that line becomes a line of resistance on the morning of January 20 th. But you can see price moving back above the line shortly after noon on

4 I have covered HAF (Heiken-Ashi Fractals) elsewhere, so I m not going to repeat all of that here. Chart # 2 also shows a blue arrow pointing to the Tenkan-Sen. Notice how the Tenkan- Sen moves down and through the midline of the Bollinger Bands on the left side of the chart and then moves up and through that line on the right side of the chart. The Tenkan- Sen will often act as a line of support or resistance once our trade qualifies on the five minute chart. C. MACD (Moving Average Convergence Divergence) I ve already mentioned the MACD in the section under Renko. Here s a sample of the MACD chart for the HA candles so we can talk about the various elements. Chart # 3 There are three main components of the MACD as shown above. The orange arrow points to the MACD histograms. While they are not essential to our study, they provide a nice visual of the basic trend of the current stock. The green arrow points to the signal line or the 0 line. You ll notice that histograms above the signal line indicate a bullish stock and histograms below the signal line indicate a bearish stock. (While this is basically true, it is not enough in itself to guide our trading decisions.) The blue arrow points to the MACD lines which are moving averages of price. Since we are using HA as our base candle, the MACD will look slightly different that a standard candle MACD. One of the key elements of the MACD is the moving average lines crossover pattern. This normally indicates a change in price and investor sentiment. But, as you ll see later in this text, there are exceptions to this rule.

5 After the moving average lines cross at the blue arrow, they diverge (become separate and further apart). This divergence illustrates the relative strength of the current trend via the faster moving average. As the lines converge, it illustrates the trend is weakening and investor enthusiasm for this rally is waning. When you lay a price chart or a MACD on its side, it often resembles an S-curve as price and the indicator both ebb and flow with the movement of price. When these moving averages move above the signal line, then this is another bullish indicator of price. Once both lines are above the signal line and they later cross back down while staying above the signal line, then a new cross up while above the signal line is very bullish. The opposite of these signals would be bearish signals of course. D. PVT (Price Volume Trend) Our next chart pane is of PVT. This is a fast moving indicator that I plot on a one minute setting and I leave on that setting when trading the eminis. Here is a sample of that chart: Chart # 4 PVT is a highly sensitive indicator by itself. It does not have a maximum and minumum range as many other indicators (such as Stochastics and RSI), so the fact that it is high or low on the chart is meaningless. It is for these reasons that I ve added a 4 moving average of PVT and an 18 moving average of PVT. There is nothing magical about these numbers. But I have found that the 18 moving average of PVT works as a trend guideline for price and the 4 moving average of PVT acts as a confirmation of a change in that trend.

6 In Chart # 4, raw PVT is the yellow line, with the orange and blue lines representing the 4 and 18 moving averages respectively. On this chart, you can see how raw PVT and its 4 moving average have fallen below the 18 moving average of PVT on the left side of the chart. This indicate a confirming bearish move in the stock. The cross of both lines back above the blue line on the right side of the chart indicates a bullish move. Since PVT is very sensitive at this one minute level, you will see it dance around its 18 moving average at times. A move like this that only lasts one or two minutes is not too alarming. But if it lasts longer, then the 4 moving average will probably also fall below the 18 moving average. When all three lines begin running in the same direction, then you have a confirmation of a new trend. And this can happen quickly. Sudden movements in price can cause raw PVT to suddenly spike. A large divergence between raw PVT and its 18 moving average can sometimes invite profit taking as investors take profit on the spike. Whether the trader should follow suit and then re-enter the trade is another matter of discretionary trading, but it is best pursued only after more experience is gained using this indicator. So these are the chart components for our strategy. Now we look at the strategy itself. II. The Emini Strategy I think it is best to think of the emini strategy as having five parts. These are: the entry, the confirmation, warnings, the exit, and divergences. So let s look at each part. A. The Entry. As you can tell in the videos that accompany this document, several things occur at the same time to indicate a buy signal. For the purpose of this document, I ll be talking of the qualifications for going long on the ES/SPY. 1. The one-minute Renko MACD lines begin to flatten out from their previous curve, as mentioned above. 2. The five-minute Heiken-Ashi (HA) MACD lines begin to flatten out in the same way. 3. A five-minute HAF (Heiken-Ashi Fractal) occurs. (We get a change in color and type of HA candle that violates the previous body high (PC1). 3. The one-minute HA MACD lines crossover. 4. The complete body of a one-minute HA candle appears on the opposite side of the

7 midline of the Bollinger Bands. (If it was below the midline, then it is now above the midline.) 5. The one-minute Tenkan-Sen crosses the midline of the Bollinger Bands. 6. One minute Price Volume Trend (PVT) and its 4 moving average crosses above the PVT 18 moving average. All of these things tend to happen at once, or at least in rapid succession. When this occurs, then we have a confirmed buy signal and we have to place our limit order quickly at the current price. Price will sometimes move quickly after these crossovers occur. So, if your limit order is not filled within the next minute, then it may be best to choose a market order. (It is difficult to make a hard and fast rule here, but you don t want to keep setting limit orders below the current price and keep chasing price as it moves higher.) B. The Confirmation. After you are in the trade, then you are looking for certain elements that confirm your trading decision. Markets can move quickly at times and very slowly at other times, so you continue to monitor the trade and watch for confirmation that the trade is going in the right direction. Your P/L BookTrader column will also give you immediate validation that you have entered the trade correctly and that you didn t place a sell order when you meant to place a buy order. Here are the confirming signals: 1. The one-minute Renko bricks cross the Tenkan-Sen. 2. The one-minute Renko MACD lines cross over. 3. One minute HA candles stay above the midline of the Bollinger Bands. 4. Five-minute MACD lines crossover and diverge. 5. One-minute PVT 4 moving average stays above the 18 moving average 6. Five minute HA candles denote a continued trend 7. Five minute HA candles cross the midline of the Bollinger Bands These confirming signals give you reassurance that the current trade will make a profit. Now that you are in the trade, you begin to watch for any warning signals that the trade may not continue in your favor. You want to lock in as much profit as possible. But you also realize that you will never exit at the peak price. You are simply trying to juggle the twin objectives of letting the winning trade garner as much profit as possible while also

8 not allowing it to move too much against you before exiting the trade. To achieve these twin objectives, we turn to possible warnings that the charts will provide to us. C. The Warnings. With discretionary trading, the trader has to make trading decisions in the midst of signals that are ambiguous at times. There is no way around this. There are certain absolutes that we ll cover in The Exit section. These absolutes will let you know that, regardless of what you think might happen, you will exit the trade if these things occur. But the warnings included in this section can give you an early heads up so you can make judgment calls that may give you a reason to exit the trade before the indicators give you a complete exit signal. Here are the warnings. Pay attention when you see these things: 1. One minute MACD crossovers. Sometimes the MACD can give false signals. This can especially occur when price is flat. And I ll talk about the MACD again later in this document. That said, you should pay attention to the charts if the one minute MACD crosses back down. Pay attention does not mean exit the trade. As a rule, if the one minute MACD is still above the signal (0) line when this occurs, then it s less of a problem. And, the one-minute Renko is your go-to on this call. The oneminute MACD can cross down during periods of price consolidation, while the one minute Renko bring remains unchanged. 2. PVT drops below the 18 moving average. During periods of price consolidation, you will see PVT bounce below the 18 moving average. What you don t want to see is PVT and its 4 moving average both below the 18 average for more than a few minutes. 3. Five minute HAF. This can signal a reversal. But one your references in this case would be the one minute HA candles relative to the midline of the Bollinger Bands. 4. One minute HA candles touching the midline of the Bollinger Bands. It is common for price to test this one minute line of support. What you don t want to see is the full body below the midline of the Bollinger Bands on either a one minute or a five minute chart. 5. One minute Tenkan-Sen crossing the midline of the Bollinger Bands. Again, this can happen during periods of price consolidation. Price can recuperate from this since it is only on the one minute chart during an existing trade. But watch out for one minute full body HA candles below the midline of the Bollinger Bands. 6. Price is approaching a known line of support or resistance. In the videos that accompany this text, price met resistance when the morning gap down was filled. Since this previous day s closing price was known to be a possible line of resistance, then an

9 exit at or near that line would have been an acceptable decision. Since price had already made a large move relative to that day s trading session, it would take substantial strength (which the market had not shown on that day) for price to push through that line. Again, some discretionary judgment is involved in trading. So when do these warnings morph into an actual exit of the trade? D. The Exit. Basically, when you see the opposite of all the reasons that got you into the trade, then you exit the trade. But let s be specific. The following things will occur in close succession: 1. A flattening of the MACD curve on either the five minute HA chart and/or the one minute Renko chart. 2. A full body HA candle on the opposite side of the midline of the Bollinger Bands. 3. A one minute HA MACD crossover. 4. A one minute Tenkan-Sen crossing the midline of the Bollinger Bands. 5. PVT and its 4 moving average below the 18 moving average. When all of these things occur, then you should exit the trade. If you are in a long position, then you will simply enter a limit order next to the current price in BookTrader. Once again, price can move quickly at this point, so remember the rules mentioned earlier about executing the trade with BookTrader. E. The Divergences. I have mentioned this briefly, but it deserves mentioning again. There are two problems with using the MACD as an indicator. One is that it is by nature a lagging indicator since it s lines do not cross until after price has already moved. The other problem is that it can signal a reversal when price is actually trending sideways. This is one area in which the Renko charts can be helpful consultants. If price is flat, then Renko charts will not show a new brick in either direction. No new brick will appear. But MACD can show a crossover pattern during this time because it is measuring average price moves from several earlier periods. So, the first thing to do when you see a MACD crossover is to confirm that it is actually reflective of what is happening with price. Price is always your first portal into investor sentiment. And the HA candles are useful for showing you the current trend of that

10 sentiment. Another place to look is price relative to the one minute and five minute Bollinger Band midlines. Price will have to pass through the one minute midline before it passes through the five minute midline. But if you are holding a long position, you want to see price being supported by that midline, regardless of what the MACD is telling you. Summary In this paper, I have laid out the various chart components as well as the strategy itself. Each day in the market is different. On some days, the market will gap in one direction and continue in that direction for the entire day. On such days, you may be able to jump into the trade and ride the one minute Renko chart all the way until the end of the day. On other days, you will have periods of choppy trading followed by slightly larger trends and S-curves. While these sorts of days are more challenging, you should still have a profitable day by using these charts and strategies. In the morning, the Renko bricks have to catch up with the morning gaps and this can take several minutes. So, you will usually start with the one minute and five minute charts that are not based in Renko. After 10 o clock or so, the Renko charts can be added to provide the basic framework for the trading strategy, as well as for the other benefits mentioned. In this document, I have gone into detail about the specifics of both the charts and the indicators. At first sight, this detail may seem laborious. But hopefully this document can be printed out and used as a guide for successful trading. Over time, you will feel more comfortable using this multi-indicator strategy and this will aid you with your trading.