Shallow pullback to 10-day MA in downtrend
Moving averages are great tools to use when analyzing a trend
and determining good buy-in prices. One of the easiest ways to identify a
stock’s trend is by looking at the moving average. A stock riding above
its moving average is trending up, and a stock riding below its moving average
is trending down. Different time frames for the
moving averages
give traders numerous perspectives to view the trend and price, depending on
your personal time-frame comfort zone or interest. Many times a downtrending stock will pullback against the direction of the trend to
a short-term overbought condition at the moving average. Depending on the time frame and
the momentum of the stock, price will usually fall back into the direction of
the downtrend because the price has stretched too far against downtrend on a
short-term basis.
Let’s take a look at how to use the 10-day simple moving average
(SMA) to
short the forex market in a pullback. The 10-day SMA, because it is such a
small time frame, creates less resistance than a 50-day SMA would, because there
are less data points in the 10-day. That said, let’s take a look at some
charts to see how price reacts to the 10-day SMA when pulling back in a
downtrend.
The first thing to do when looking for pullbacks is to
identify the trend. We are shorting the currency, so look for a stock that
is riding below its SMA. Then wait for a good pullback opportunity, when
price makes a move towards the SMA before continuing its move. The first
real pullback that occurs in the chart is a very dangerous pullback entry,
because price actually breaks resistance and closes above the SMA twice in a row.
This is definitely a holding pattern for our short, because we don’t want to get
in as momentum gains for the bulls. Over the next month and a half, we see
consistent, repeated pullbacks to the 10-day SMA. After each pullback,
price makes a continuation move down, because of the short-term oversold
conditions at the moving average.
After price begins to break the SMA repeatedly in both directions, it is safe to
say that we have lost the trend and cannot aggressively pursue any pullback
opportunities.
Let’s take a look at one more chart just to see another
example of price pulling back to the 10-day SMA. The U.S. Dollar fell
against the Japanese yen in April ’06 until the middle of June. During
this time, price pulled back to the moving average twice during it’s downtrend,
not including the initial pullback that initiated the long fall. A great
thing about this chart is that it shows the flip-side of this equation.
After bottoming out and reversing the trend, the Dollar initiated a rally to the
upside, pulling back to the SMA a few times on the way up.
Try using pullbacks to the
10-day moving average to get a better price in an uptrend. The 10-day SMA
is a relatively short-term indicator, but price support can be found there,
giving traders a great point of reference when trying to optimize a pullback
trade.
John Patrick Lee
Associate Editor