So far, we’ve gone over how to find stocks with news and how to find stocks with EquityFeed. Both of those strategies are intended to be used more for penny stocks. I use this next strategy mostly for NASDAQ’s, however, it can be used for a variety of different stocks.
If you don’t have a stock scanning tool by now, you need one. Stock scanning tools add a whole new dimension to your trading. They let you find the hottest stocks and filter out the junk. I’m sure there are a lot of great scanners out there. I use 2 main ones, and I will discuss them both.
FinViz: The Free Option
FinViz is a completely free stock scanner, so you have no reason not to use it. They have a wide variety of ways you can filter stocks, from fundamental statistics to technical indicators. Don’t let the “free” part deter you – this is a top-notch service. I will mostly use this tool after hours when I don’t feel like using my multi-monitor setup for other scanners.
Mess around with different scans and see what works for you. I don’t have many saved scans for this tool. I like to try different things. The goal is to create filters that align with your strategy. Experiment with different inputs until you get the right outputs.
My favorite part about this tool is that it displays a lot of charts all at once. This makes it easy to go through hundreds of charts and quickly spot the ones you like. Additionally, their technical charts include some trend lines and patterns that may help you spot nice charts faster.
E*TRADE Pro: The Paid Option
E*TRADE Pro Strategy Scanner is my main scanning tool. I use it during market hours and after hours as well. This tool is crucial to the success of my day trading strategies.
I believe that E*TRADE Pro charges $99, however, if you make at least 30 trades/quarter, the software is free.
The strategy scanner module allows you to set criteria for stocks you want to find. You can run real-time scans or scans from previous days.
I have four main scanners setup during trading hours.
Main Scanner
This scanner is the most active. It is intended to find hot stocks for scalp trades or breakout plays. A lot of the alerts are useless, but I have a good feel for which ones are the best, and I am constantly refining the scanner’s criteria.
I filter stocks by price, # of trades, dollar volume, and total share volume.
I receive alerts for stocks setting new highs, breaking above or below 20/50/200 day moving averages, forming symmetrical triangles, breaking out of consolidation ranges, forming bullish candlestick patterns, and more.
During the day, I keep an eye on a stock’s relative volume and the number of alerts it has had in order to better assess the quality of the alert quickly.
Social Scanner
This scanner tracks increased StockTwits activity for stocks. Remember, stocks are considered “in play” when they have a large audience and high volume. This increased social activity indicates that there is a large audience. You’ll also notice that there is high relative volume for most of these alerts. This scanner is nice because it only delivers a few alerts each day, so I’ll just glance at it a few times each day.
I only filter these stocks by price (under $10)
The only alert is increased StockTwits activity.
Penny Stock Scanner
This is another scanner that only delivers a few alerts each day. I use it to find good penny stocks for swing trades.
I filter stocks by price, dollar volume, and share volume.
I receive alerts for stocks setting new highs or lows, or breaking above the 50 or 200 day moving averages.
Watch List Scanner
I have hundreds of symbols on different watch lists, but I like to keep my main watch list small in order to stay focused. That being said, I don’t want to miss a move on a stock I am familiar with. So, I set up a scanner that scans all of my watchlists and alerts important activity.
I filter stocks by their dollar volume only.
I receive alerts for high relative volume, new highs/lows, and 20/50/200 day moving average crosses.
In Conclusion
Scanners are a crucial tool for active traders. They allow you to be aware of what is going on in the market at all times. Additionally, they allow you to find stocks that are moving before other traders do. The point of showing my scans was just to give an idea of what you can do with these tools. When you create scans, they should align with your trading strategy. Otherwise, you will get a bunch of alerts that you can’t act on and the scanner is useless. Creating a good scanner takes time. I refine my scans on a regular basis. The more you use the scanner, the better you understand it. This allows you to filter out bad alerts and better refine your scanner inputs.
If you have any questions, feel free to contact me through the contact page on my site.
Check back tomorrow for the final post in this series, How to Find Stocks Using Social Tools.
In my last post, I discussed how to find stocks using press releases. If you are trading every day, you can’t rely solely on good press releases. You need other options. The main tool that I use for finding good OTC penny/subpenny stocks is EquityFeed. The tool has a monthly cost, but there is a free trial available for you to test out the software. Let me make it clear that I am not trying to force this software on anyone. I am bringing it up because it is a valuable tool in my arsenal of trading software. You can probably apply some of these strategies without EquityFeed if you would prefer not to buy the software, however, I do recommend checking it out.
Let’s get right to it. Here’s are the many ways I find stocks with EquityFeed:
News:
Equity Feed has a streaming news module. This module constantly refreshes and alerts you whenever there is press releases or SEC filings for OTC companies during the trading day. This allows you to react to these catalysts much faster than traders who are using slower sources for news. It also allows you to view important data such as the stock’s volume, price changes, etc. You can filter the news by keywords, types of stocks, and other criteria.
Market View
Another one of my favorite features of EquityFeed is the Market View feature. This shows you all of the OTC stocks and allows you to sort them by different criteria. I split this feed into stock that are under $0.10 and stocks that are between $0.10-$0.50. Then, I sort the stocks by their dollar volume for the day or the # of trades. This allows you to see what the hottest stocks are during the day and make trading decisions accordingly. It also helps you find stocks that may be hot the next day as they continue their trends. Of course, you can filter these lists down even further, but I like to keep it simple.
Trading Alerts
This window gives you live trading alerts throughout the day and organizes them by type (each color is a different type of alert). You can create alerts for new highs, new lows, unusual volume, and block trades. This assures that you are always aware of what is going on in the market. When people bring up stocks breaking out in chat rooms or on Twitter, I have already been alerted in EquityFeed much earlier. Setting up alerts is very easy to do, unlike some other scanning tools.
Filter Builder
EquityFeed has a feature called Filter Builder that allows you to scan the markets for stocks with very specific criteria. For example, you could create a filter for stocks with increased volume approaching their 200 day moving average. You can use this tool for live streaming during the day, however, I rarely do because I already have the trading alerts window. I will use this tool at night to find stocks that may be good swing trades or day trades for the next day. There are so many different filter variations you can make it so you need to constantly test new strategies.
Before you can enter a trade on any given day, you need to have a list of stocks ready to trade. If you are an active trader, your watch list should be dynamic and reactive to the markets. Having the right stocks in your watch list can make or break your success on any given trading day.
Over the next few days, I will be posting a few articles detailing ways to find stocks to trade. Let’s start with the basics.
When building a watch list, you want to find stocks that are “in play” or “hot stocks.” If a stock is not in play, you really have no reason to be trading it. So, what exactly does it mean when a stock is “in play”? It means that there is some excitement/hype surrounding the stock. People are watching the stock closely and waiting to make a move. This means the stock has a large audience who may support the move when the time comes.
The first way to find a stock that is “in play” is through news sources. When a company releases news, it means something has changed within the business. Consequently, something should change with the stock price. The news is a catalyst. If it is good news, the stock should go up. If it is bad news, the stock should go down.
News Sources
Most of the news I read is for penny stocks, because these are the stocks that can move 20%, 40%, 50%+ on a single press release. I don’t read much news for bigger companies during trading hours because there are far too many of them, and if it is significant news, I will find the stock when it shows up on my scanners. Below are some places you can find news for penny stocks.:
InvestorsHub News – News released through iHub. The better option for iHub news is to setup news alerts for companies you follow. You will get an email whenever these companies release news. The emails will often send before the news even shows up on the iHub site.
Marijuana Stocks News – This sector isn’t as hot anymore, but I used to check this news a lot. It’s worth a look every now and then.
EquityFeed – This is by far my favorite news source. Unlike other news sources, EquityFeed picks up on almost every news piece in real-time. There is a monthly cost, but a free trial is available if you want to test it out. I will be doing an entire post on how to find stocks through EquityFeed.
Filtering Through News
There are hundreds of press releases distributed every single day. This doesn’t mean that all of them are important. It’s very easy to send out a press release. I could send one out tomorrow if I wanted to. Learning to filter through press releases is a crucial skill for traders who incorporate news into their strategy. Considering that most of the news I read is related to penny/sub-penny stocks, I have to filter out a lot of junk.
You should be asking yourself two questions every time you see a press release:
1. How will this news effect the company?
2. How do I believe people will react to this news?
Both questions are equally important. For example, a company may release news that they sold 1000 cases of their product to a recognized brand like Circle K. You do your research and learn that this company’s profit margin is terrible and this sale will likely be a one-time transaction. You just answered the first question. Now, proceeding to the second one. How do you think people will react when they find out a small penny stock company landed a deal with a brand like Circle K? Less diligent investors may get excited and purchase shares. You can usually determine the reaction to news based on price action and volume. Just make sure to ask and answer both questions.
Let’s break news down even further now. We have a few categories of news that I think are important enough to discuss.
Good vs. Bad – This one is simple. Is the news good or bad? A company may report a toxic financing deal or bad earnings. This is bad news and you can expect the stock to go down. Contrarily, a company may report an impressive new contract or good earnings. This is good news, and you can expect the stock to go up. It’s as simple as that.
“Fluff” vs. Important News – Not all news is really “news.” Some companies just release news to keep people focused on their stock, or simply because they don’t know any better. By asking the question “How will this news effect the company?” you can filter fluff news from important news.
Expected vs. Unexpected News – You’ve probably heard the expression “buy the rumor, sell the news.” A lot of people buy a stock in anticipation of expected news. This means that the news has already been factored into a stock price. In these cases, a stock may go down on good news as traders collect their profits.
In Conclusion
Understanding how news will affect a stock price is not a science. You are not dealing with just the news; you are dealing with the mass reaction to the news. It still baffles me when I see certain press releases that move a stock’s price. You won’t be able to catch every move – focus on the best ones. Additionally, I will rarely trade solely based off of news and don’t recommend it. News is just a catalyst that brings attention to a stock. Once you find news that catches your eye, you should still apply your regular trading strategy to the trade (technical analysis, fundamental analysis, etc.)
Be on the look out for Part 2 of this series tomorrow: How to Find Stocks with Equity Feed.
In another post, I talk about understanding Level 2 screens from a supply and demand perspective. This article builds on the supply and demand concept by focusing on who is supplying and demanding shares of a stock. This doesn’t matter as much to me for bigger board stocks, but I will always analyze the market makers for an OTC penny stock.
What are Market Makers and Why Are They Important?
Market makers control the stock market, which means that the fate of your stock is in their hands. When you place an order for a stock, your order is sent to a market maker who fills the order for you. Think of a market maker as a middle man of sorts. If you want to buy 100,000 shares of a stock at $0.05/share, you send the order to your market maker and they present that order to sellers. Just like if you wanted to buy a house for $500,000, you would tell your real estate agent, and they would pass that offer along to the seller. Modern technology makes placing orders a speedy process that most give little thought to. It’s easy to look at a Level 2 screen and think of all market makers as equals, but each market maker is unique and understanding their behavioral trends can help you place better orders. As we know from a previous article, supply and demand levels are what determine a stock’s value. Knowing your market makers allows you to understand who controls the supply and demand for a stock, giving you a more thorough understanding of your market environment.
Knight Capital Group (NITE) market makers.
Which market makers are important?
Different market makers will be important for different stocks. It’s important to analyze the level 2 screen for each stock individually. Keep in mind, that different market makers may behave differently on each stock. The best way to figure out which market makers are important is by analyzing the level 2 screen for a couple of days to get a feel for how the stock trades. Look for things such as which market maker controls most of the volume, how many shares the market maker shows vs. how many they actually sell, the size of the spread, and how fast the market maker allows the stock to move in either direction. I also like to check a stock’s historical trading volume by market maker. Market makers are required to submit their reports of shares sold each month. The data comes out at the end of the month, so it’s not real time, but still a handy tool. You can check the monthly share volume report for a stock by clicking here.
Remember, the main focus is to learn how a stock trades and all analyses should be relative to this goal.
I don’t want to talk too much about specific market makers, as that could take all day. I’ll just cover some basics:
Notable Market Makers for Penny Stocks
When most traders place an order to buy/sell a stock, it usually goes through a wholesaler or ECN (electronic communication network). Some popular market makers for these types of transactions include NITE, ATDF, ETRF, and ARCA. A look at a monthly share volume report will show you that these market makers handle a lot of volume. Certain brokers allow you to choose which market maker you route your order through, however, most discount brokerages such as E*TRADE will route it automatically. When I see these market makers on a level 2 screen, I will usually analyze the orders to gain some insight into the psychology of the traders in a stock. I assume that these orders have been placed by traders (not MMs) until being given a reason to assume otherwise. So, for example, if I see ETRF put up a bid to buy 100,000 shares of a stock, I will assume that was placed by a trader and not just an MM trying to balance the market. That being said, the latter is also a possibility and these MM’s can still play games and manipulate a stock price. Regardless, analyzing these orders can give you some insight as to how traders/MM’s expect the stock to move on a given day.
Dilutors
If you have been trading penny stocks for some time, you’ve probably heard the term “dilution” thrown around quite a bit. Dilution hinders a stock from running and can push the price down as well. Dilution is most noticeable when a market maker shows a certain amount of shares at a specific price, but sells much more than the amount shown (soaking up size). For example, VFIN may be showing 10,000 shares for sale but actually selling hundreds of thousands. When I see a market maker who is infamous for dilution on a level 2 screen, it is a red flag. Frequent dilutors include but are not limited to VFIN, VNDM, PERT, and VERT. I view dilution on a level 2 screen the same way I view a resistance level on a chart; price levels that will be hard to break.
Example
Here’s an example from last week’s trading of MYEC:
Anything catch your eye when you look at this?
The first thing I notice is market maker “VNDM” on the ask at .016. So, why is this significant? I’ve been watching this stock for awhile, and market makers such as VNDM and VFIN will often sell massive amounts of shares at a certain price level (dilution), hindering the stock from going up.
If you just looked at this Level 2 screen from a supply and demand perspective, things would look great. It appears that there is much more demand then there is supply, meaning the stock could run soon. Analyzing the market makers allows you to understand that there is probably a lot of supply around .016, making it difficult for the stock to run.
The stock chart confirms this. Below is a 5-minute intraday chart of MYEC’s trading action. Notice how the stock cannot break above .016 towards the end of the day. Every time it gets close, it is pushed back down as traders realize that it will be hard to break that price level.
Now, at the end of the day, VNDM moved his ask price up to .019.
To me, this means the stock has room to run up to that level, however, by this point it was too late. Many traders already got their shares for cheaper and have less motivation to push the price up. I bring this up because it’s another important point about the effects market makers have. Traders want to enter a stock when they think it has the potential to move up. When a market maker holds the price down through dilution, they make the stock less appealing. Additionally, a lot of buyers end up getting their orders filled at cheaper prices, meaning they have less motivation to buy shares at higher prices on the ask. Knowing that a stock has been diluted is a great way to understand the psychology of the traders involved.
Other Important Points:
Soaking up size – Soaking up size is when a market maker buys or sells more shares of the stock than they show on the level 2 screen. If a market maker is soaking up size on the ask, there’s a good chance it’s dilution and this is a bearish sign. If a market maker is soaking up size on the bid, that means they could be accumulating shares or creating a level of support, which can be a bullish sign.
Shorting – Many people make the assumption that market makers want to see a stock rise in price. Keep in mind that market makers can short sell a stock and profit on the way down.
Fake Big Orders – One of the best ways to mess with the psychology of the market is to show big orders on a level 2 screen. Big orders on the bid make it seem like there is a large demand for the stock, while big orders on the ask make it seem like there is a lot of supply. These levels can act as mental support and resistance levels for traders using level 2 screens. Market makers know this and can place big orders to move the stock in a certain direction. For example, if I buy 100,000 shares of a stock at .03, and it runs to .04 where there is a market maker showing 5 million shares for sale, I (along with other traders) may sell the stock. The large order may not even get filled at all, however, its presence alone has an effect.
Market Makers are Traders – All this talk of shorting, soaking up size, and fake big orders can seem like a crazy conspiracy theory. I’ll admit that there are some crazy market maker conspiracy theories out there, but it’s important to remember that market makers are traders. Just like other traders, market makers are trying to make money. Yes, it is their job to keep a balanced market, however, they are also responsible for remaining profitable. This is important to understand because it can shed light on a market maker’s intentions. For example, if a market maker shorts a stock at .02/share and the stock runs to .04/share, you could understand why the market maker may have motivation to push the price down. Don’t get paranoid and automatically assume market makers are manipulating a stock; just be conscious of what is going on and look for red flags.
In Conclusion
In no way is this article intended to be a comprehensive guide on understanding market makers. I’ve barely brushed on the topic. My main focus is to stress the importance of knowing about market makers and how they operate. The best kind of analysis you can do is real-time. Observe different market makers and their behavior and do the research necessary to allow you to make smart trading decisions. Understanding the behavior of market makers can add a whole new dimension to your trading strategy.
Understanding a stock’s trend is one of the most important things to do before considering a position. You need to know what you are getting yourself into. Recently, because of the medical marijuana stock bubble, I’ve encountered a lot of people who are surprised at just how low a stock can go. While it’s always unfortunate to watch one of your stock pick’s drop exponentially, you should be aware that the stock is following a trend. If you are looking to catch a bottom during a downtrend, you are playing with fire. It’s much easier for a trend to continue than it is for it to reverse.
Identifying a trend
Identifying a trend is fairly simple. Uptrends are classified by higher highs and higher lows (the stock is moving up in price). Downtrends are classified by lower lows and lower highs (the stock is moving down in price). It’s as simple as that. Sometimes, there will be no clear trend present and the stock is considered to be trading or consolidating instead of trending. More often than not, you can identify a trend simply by looking at a stock chart. It’s important to understand that stocks have different trends for different time frames.
Trends Across Different Time Frames
Different traders have different goals and trading styles. Some will hold stocks for a day, while some will hold for months or years. It’s important to pay attention to the trends that affect your trading style as well as the other trends. According to Dow Theory, there are three main trends that may affect a stock: primary, secondary, and short term.
Primary Trend – The primary trend usually accounts for a stock’s price action over the past year or few years. Based on my style of trading, I’ll usually look at 200-Day chart to see the long term trend. Primary trends are of most interest to investors who will hold a stock for months of years.
Secondary Trends – The secondary trend usually accounts for a stock’s price action over the past few weeks or months. Based on my style of trading, I’ll usually look at a 50-Day chart with a stronger focus on the past 20 days. Secondary trends are of most interest to swing traders who plan to hold a stocks for a few weeks.
Short Term Trends – Short term trends account for a stock’s price action over the past few hours or days. I usually look at a 30/60-Minute chart for the past 10 days, as well as intraday charts on 1,2, and 5-minute scales. Short term trends are of most interest to day traders looking to get in and out of a position within the day or a few days.
Below is a 2-year chart of AMBS showing the primary, secondary, and short term trends. (This chart was chosen at random based on a stock I was playing today. In no way is this post intended to influence you to buy or sell this security. This is for analysis only) Notice that the primary trend is an uptrend. The stock has been rising off of its lows since November 2012, consistently setting higher highs and higher lows. That being said, the secondary trends varied. The stock experienced a downtrend during the first 6 months of 2013. During that secondary downtrend, the stock experienced some great short term uptrends. AMBS ran up nearly 100% during the first 10 days of April 2013.
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Clearly, it is important to align your trading goals with a stock’s trend. If you bought AMBS in November 2012 and planned to hold for years (which I never recommend doing with penny stocks), you would have experienced a nice 3700% as the stock ran off its lows of about .005 to highs around .19. If you bought in January 2013 and planned to hold for a few months or weeks, you would have been disappointed as the stock dropped from highs of about .19 to lows of around .027. The point being that the trend you follow should match your trading style. If you went long AMBS anytime between January-June of 2013 for a swing trade, you were fighting the secondary trend. If you were looking to invest in AMBS during that period with plans to hold for over a year, you had less of a reason to worry, as the stock did not break the primary uptrend.
Let me make this clear, DO NOT FIGHT THE TREND. Trends are more likely to continue than they are to reverse. As mentioned above, if you are trying to catch the bottom of a stock, you are playing with fire. It’s easy to rationalize a purchase like that. You don’t want to miss the big move. You figure the stock has been dropping for days and is due for a bounce. The stock seems undervalued at these prices. It’s better to miss a big move upward than to jump into a big move downward. Sure, the stock may bounce soon, but you should be prepared to stomach the losses if it does not. Know that by the time the stock does bounce it may not even bounce high enough for you to break even, as you are in a stock where a lot of people are looking for the first chance to get out (causing lower highs).
Trend Reversals
Let’s look at the AMBS chart from before and see how you can spot trend reversals. I like finding trend reversals so I can initiate a swing trade. I’m looking for reversals in a stock’s secondary trend. I don’t care about the primary trend because I don’t hold stocks for that long. I’m not focusing on a short-term uptrend during a secondary downtrend, because that’s a different kind of strategy. Here are a few ways I spot trend reversals.
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Look at the Chart – AMBS was dropping from January 2013 to June 2013. Eventually, the chart started to bottom out. Keep in mind that charts don’t bottom out over night. It can take months. AMBS started a period of sideways trading between June 2013 and August 2013. It formed a clear level of support, and volume started to slow down. There was also a clear level of resistance forming. This represents a period of indecision in the market. There’s no reason to expect any big moves during this period. You can scalp trade and play the volatility, but that can be risky. In hindsight, you can see that the stock consolidated at these levels and made its way higher, but that’s not always the case. Think of this period of indecision as a battle between the bulls and the bears. The bears keep pushing the stock down and the bulls keep pushing it back up (neither of them shifting the trend in their favor). If the support line is broken, the bears win. If the resistance line is broken, the bulls win. In this particular case, the bulls won and the stock continued to run for about 2 weeks. This breakout was eluded to by higher highs and higher lows being formed on the chart. When the stock broke through resistance, it went parabolic and the price went up almost 100%. You should also pay attention to the increased volume, as it shows you that the stock was getting the interest of traders as it ran up and traders tried to catch the move.
This kind of move is best understood when you think about the psychology behind it. Follow along on the chart to understand. AMBS ran from lows of about .005-.006 in October/November of 2012 to highs of about .19 in January 2013, during which time the stock had huge volume. This means that most of the shareholders bought the stock in the price range of .005-.19. What would you do if you bought at .19 and the stock started plummeting? Chances are, you’d look to get out of the stock asap in order to cut your losses. So, the selling begins. What would you do if you bought at .005 and the stock was dropping? Chances are, you would sell your shares to lock in profits. So, the selling continues. During this time, other traders are buying those shares. As the stock continues to drop, a lot of those traders will start to sell their shares, realizing the downtrend is not over yet. So, the selling continues. All of these people stuck holding the stock are looking for a way out. This explains the psychology behind the formation of lower highs. Every time the stock bounces a new group of stuck shareholders decides to sell either for profit or to minimize losses. This goes on for awhile until an equilibrium price is reached. Everyone who wanted out of the stock got out, so the selling slows. Supply of the stock has now dwindled (remember the market is all about supply and demand). That being said, demand hasn’t increased quite yet. New buyers recognize that the stock has been downtrending for awhile and are not quick to jump into a position. Volume is slow during this period. Shares are exchanging hands within a tight price range (a period of trading). This period is like a refresh/filtration of the stock’s shareholders. Now, instead of having a bunch of shareholders who bought in between .005-.19, there are a bunch of shareholders who bought in between .03-.045 (look at the chart). These shareholders have way better entry points than their predecessors. They have less reason to impulsively sell their shares to cut losses or take big gains, so they hold shares. This period of trading is also known as accumulation. During this period of indecision, these new shareholders are looking for a big move in either direction. Eventually, the stock starts making it’s way upward, setting higher highs and higher lows as supply decreases and demand increases. AMBS has a history of huge breakouts, so this catches the attention of even more traders who believe a breakout may be coming. This breakout could be triggered by a news-related catalyst, short squeeze, or it could just be a technical breakout. The point being that demand for the stock has increased, as shown by the increased volume.
Trend Lines – Trend lines can be drawn on a chart to give you an idea as to the stocks general movement. Sometimes you will have to draw multiple trend lines and choose which one is in play at the moment. Drawing trendlines is an art, not a science. Trend line crossovers can signal a change in trend. It’s much easier to see which trend lines are in play in hindsight, however, this is just one of many tools you will use to spot reversals. Here is an example of AMBS trend reversals using trend lines.
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Moving Averages – Moving averages help to smooth out price action, which can be helpful for spotting trends. I use simple moving averages for the most part, however, I will sometimes use exponential moving averages when a stock has been making faster moves. These are the moving averages I use for trend spotting on a daily chart:
200 Day Simple Moving Average – Primary trend
50 Day Simple Moving Average – Secondary trend
10 or 20 Day Moving Average – Short term trend
Let’s look at these moving averages on the AMBS chart.
200 Day Simply Moving Average – This MA reacts the slowest to recent price action.
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Notice that the 200 DMA starts to flatten out and curve up towards the beginning of 2013
Then the 200 DMA starts to curve down a bit in October 2013, signaling a potential reversal in the primary trend
The stock sets higher lows and the primary uptrend continues as reflected by the 200 DMA in December 2013
50 Day Simple Moving Average – This MA reacts to price action faster than the 200DMA but not as fast as the 20DMA. Notice that it can foreshadow trend reversals, however, it is a bit slow. It also ignores random price fluctuations such as short lived breakouts.
Click image to enlarge
Notice that the 50 DMA starts to flatten out during the end of 2012 and starts to curve up around the beginning of November 2012. The 50DMA eludes to the major breakout much before the 200DMA does.
Notice that the 50 DMA curves downward in the beginning of March 2013. It eludes to the upcoming drop when the stock is trading at around .07 and doesn’t curve up again until the stock hits .03
The 50DMA flattens during the period of consolidation discussed above and starts to curve up as the trend reverses.
The 50 DMA starts to curve down again as the breakout was short lived
The 50 DMA curves back up and continues the upward momentum
The 50DMA curves back down as price starts to drop further
the 50 DMA curves back up as another run starts to happen.
20 Day Simple Moving Average – This MA reacts pretty fast to price action. This is both good and bad, as you’ll see below.
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The 20 DMA eludes to the breakout almost right away. It only uses 20 days of data so it reacts fast to sharp moves.
The 20 DMA starts to flatten out and dip, giving somewhat of a false warning. This is a good sign for short term traders, however, as we see, the breakout continues.
The 20 DMA warns of the upcoming drop when the stock is still in the .9-.10 range, giving traders a lot of time to get out before the stock bottoms around .03
The 20 DMA reacts to the bounce during the downtrend. Unfortunately, by the time it curves up, the breakout is almost over. Yet another false signal.
The 20 DMA starts flattening and eludes to the upcoming breakout before the majority of the move occurs.
The 20 DMA starts to curve down at when the price is at .06-.067 before the drop to .04
The 20 DMA curves back up eluding to yet another breakout
The 20 DMA curves down eluding to a breakdown
The 20 DMA curves up eluding to a breakout (Hopefully this is getting redundant by now)
Other important things to note about moving averages
Trending stocks will often find support and resistance at their appropriate moving averages. (eg: long term support should be at the 200DMA when the stock is trading above it). Notice how the 20DMA acts as support during up trends and resistance during downtrends in our AMBS example.
Trading below longer terms MAs (50/200) is a bearish sign. Trading above can be bullish.
Trending stocks tend to have MA crossovers. In a strong uptrend you’d expect the 20 DMA to be above the 50 DMA and the 50DMA to be above the 200DMA, although this won’t always be the case. Look at the most recent uptrend in the AMBS example to see this.
Keep in mind that there is no magic formula for using moving averages. They are simply a tool to help smooth out price action. The analyses I made above were done in hindsight, which is much easier. Every stock will react differently to their moving averages. For example, a lot of people expect the 200DMA to hold as support (as mentioned above). This is speculation, and not a rule. Anyone can sell below the 200DMA very easily. Use different MAs to help spot trends, but don’t trade solely off of MAs. There are a lot of other tools that you can use.
