A Little Trick in Friday’s Trend Day Up

Friday gave us a solid, upward performance in the US Equity Indexes.  Let’s zoom in to the 5-minute chart and learn a valuable lesson regarding Trend Days and Stop-Loss Strategy or Trade Management.

DIA 5-min February 6th 2009:

Friday’s action wasn’t an “Ideal” Trend Day, but a Trend Day it was.  Most trend days open with a large-scale overnight (or morning) gap, though Friday’s action was gap-like (not technically a gap).  Momentum and price soared to new highs right off the open, clueing us in to a possible one-sided market, as price made no meaningful attempt to retrace any of that move.

The first pullback to the rising 20 EMA came in just after noon (price was too strong to manage a retracement to the average before then, preventing a clean entry).  There actually were two such pullbacks, the second of which occurred at 1:00pm.

Those who love range contraction bars (NR7s, Dojis, etc) must have enjoyed the 1:00 consolidation, as it gave a clean entry (long if we break above… short if we break beneath) and price found support at the rising 20 EMA and rocketed to a new intraday high.  It formed on a negative divergence, but remember it’s best to ‘turn off indicators’ on Trend Days (they give false signals as price continues higher).

Still, the bias was higher, and we came up into the lesson I wanted to highlight in the chart.

Generally, the plan on a Trend Day is to enter in the direction of the trend and play it until the close.  The 50 EMA becomes the “Line in the Sand” wherein you drag a trailing stop.  Stop-Loss Strategy comes down – in my opinion – to conservative or aggressive methodology.

If you’re a Conservative trader (like I tend to be), you’ll place your stop tight (close) to the 50 EMA.  In this case, you were probably prematurely stopped out (whipsawed) as price smacked through the 50, “nailed some stops” and then reversed back to test the intraday high into the close.

If you’re an Aggressive trader, you’re more likely to allow price to ‘wiggle’ more, meaning you placed a stop a reasonable distance beneath the rising 50 EMA.  In this case, you accounted properly for the volatility and probably kept your core long position into the close.  Had price reversed down, you would have taken a larger loss than the conservative trader, but this is a clear example of why it often pays to give price a little more ‘wiggle room’ in these volatile times.

It’s up to you to decide which methodology you’ll adopt, as they both have trade-offs you’ll have to discover.  Tighter stops result in more stop-losses (and whipsaws) but each of them result in less money lost.  Wider stops result in less stop-losses being hit (whipsaws) but when they’re hit, they’ll cost you.

No one can give you an easy answer as to how to reconcile the two.  Use today’s trend day as an example of how your stop-loss strategy can be helpful or hurtful to you in these volatile times.

Corey Rosenbloom
Afraid to Trade.com