Traders Overwhelmed by Conflicting Indicators: Get Back to Basics
Here, a look at ETFs IWM, XLF to understand some very basic things a trader can do to gain perspective, especially in a market such as the current one.
With the market averages seemingly under pressure at current levels, I find that using some very basic tools helps me to sort through the noise and keep myself sane. While there is not a perfect indicator or Holy Grail that will flawlessly predict the next move, it is my goal to push the odds enough in my favor to be able to take excellent risk reward trades time after time.
On the weekends, I will go through thousands upon thousands of individual charts and look for the most promising setups on both the long and short sides. After that homework is done, I will then take a look at the major ETFs and indexes and take away a bigger picture view of the week ahead. Let me share some very basic things a trader can do to gain perspective, especially in a market such as the current one. These very basic insights will help a trader stay on the right side of the market more often than not.
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The Russell 200 has been a leader off of the 2009 lows and continues to maintain this status. I like to use the IWM ETF to track its movements and give me a snapshot of the larger landscape. Taking a look at the above chart of IWM, there are only three major things I will consistently look at as a barometer. The first is the 50-day moving average. Like it or love it, the reality is that this key moving average is so widely known that to completely dismiss it is a fool's game. I know traders who like to fade the popular consensus surrounding the 50-day, and I have no problem with that. But for my dime, I want to move with the masses and merely try to be one step ahead. In the case of the 50-day, a perfect rule of thumb is to trade in the direction of the average, and only when prices are confirming. So in the current chart of IWM, the trades would be long but since price is below the 50-day there is no entry. We would want to wait for IWM to close back above, which currently would be above $83.20.
The second things I want to take from an index ETF chart are key support and resistance levels. Points C and G ($81.40) were an area of support until this week in IWM. When IWM broke this level to the downside, it confirmed a continuation of the recent rollover. $79.85 will be the next level of support to watch if we once again break lower.
The final basic component is to draw pivot points on your chart to start getting a feel for the waves transpiring. Clearly, these can be drawn in any time frame and are highly useful in helping a trader step above the fray. In an uptrending market, these higher lows and higher highs will be readily apparent and give you the added conviction to remain long. Take note of what has been happening over the past three months in IWM. After making a higher high at point "D" and a higher low at point "E", the power started to shift to the bears. Points "F" and "G" confirmed that the uptrend was under pressure and astute traders should have begun to pare back capital from the long side.
From here the waters turn a bit murky. A new low was put in on Wednesday and now I will be waiting to see if point "G" holds as a new lower high. While we have clearly moved from a bullish uptrend to a neutral stance, the verdict is still out on whether this is consolidation or a bigger topping pattern. Use daily pivots to help keep your eye on the ball.
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Now let's turn our attention to the financial ETF XLF and use it as case study on recognizing a turning point in the tape. We'll use the three indicators I shared above. First, take a look at the 50-day moving average in XLF. Early March provided the first clues that something might be taking place underneath the surface of fins. XLF struggled to stay above a rising 50-day, and the longer this struggle continued the more weight that mounted. A bounce from point "B" brought XLF right back to the 50-day, but by now it was turning down which is clear bearish signal. Once XLF broke back below this descending 50-day my mind looked for more weakness. Bumping its head once again at point "E" was my confirmation of lower prices.
Secondly, let's take a look at some key support and resistance levels. Not shown above, but on the weekly chart XLF has some major support coming up at the $15.33 level. This coincides with the 50-week moving average and as a longer term support level should be instrumental in price action going forward. Back on the daily chart, the high at point "A" corresponds within pennies to the April 2010 high in XLF. When XLF got snubbed and retreated from this level I knew I needed to be on high alert. Lastly, XLF is once again coming into a support level that was last touched in December 2010. This area has been a key inflection point going all the way back into late 2009, and combining it with similar support on the weekly will give us some very strong clues about XLF.
Turning our eyes to the pivot points in XLF, take note of the stark contrast between the trend in XLF versus that we looked at earlier in IWM. Whereas there seems to be indecision in IWM even today, that is clearly not the case with XLF. Each pivot point starting with "A" has clearly drawn the line in the sand telling us that lower prices were forthcoming. So what am I looking for now as it regards these pivot points? "G" is the current lower high and needs to be taken out for a potential change in character. And whenever the lower low currently forming is put in at "H", that would also need to hold. If not, then lower prices still remain on the horizon for XLF.
Clearly, the above indicators are all lagging indicators and only give us the benefit of hindsight. Trading in the rear-view mirror is not going to help you when the decisions have to be made in real time. Nonetheless, having a few simple methods of determining the current trend should help most traders protect capital, profit from the runs, and avoid the nasty reversals. My suggested indicators are not suitable for gaming a bounce play but are worthy of consideration if a traders goal is to be in the meat of a move. While I have shown them on major ETFs, they can be rolled down to any individual names one might be considering.
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