In this guide, we will continue our look at commonly used day trading strategies. We will begin by looking at what is known as ABCD patterns, bull flags, reversals, moving averages, support, and resistance, and then finally Bollinger bands.
ABCD
The ABCD strategy is a basic strategy that looks for a certain pattern in stock to get an idea of what the trend is in the market. What you are looking for is a stock that starts low and rises to a high point A, and then drops back down to a low point B. Point A represents the breakout level, that is if the stock passes point A, a second time during the trading day you’re expecting it to rise significantly, representing an opportunity where you can sell for profit. So why would point A drop down? This is a point when many investors have decided to sell because they are happy with their profits and they are suspicious of the stock continues to increase.
As the stock begins to be sold off, at some point it will reach a low point, which will be point B in the chart. The low point occurs when new buyers overtake sellers that began selling as a result of the stock reaching the high point A. Then, when more buyers come in the stock will settle on a new low point, C, which will be higher than point B. If this pattern is established, you take your risk level as point B. After it hits point C, it may begin moving upward again. This is a signal of a good buying opportunity so we may jump in at this point. If the ABCD pattern is realized, it will move up to a new high point D, where we can sell and take our profits.
In the chart below, if the stock goes above point A, this is considered breakout. Time to consider selling. This is a bearish ABCD, which means you see a time to sell and take profits before the stock drops again. Point B could you’re your stop-loss point. This is a bearish ABCD, meaning we expect it to drop.
Example- suppose that XYZ Stock opens strongly, going from $50 a share up to $60 a share. Then over the next hour, it drops to $40 a share. It then rises to $55 a share and drops a little bit to $53 a share. At this point, we will consider buying. Our risk level is the lowest point which was $40 a share. If the stock starts turning upward, we buy. So, we can take any point between that and our purchase point as a stop-loss, so, for example, we could set a stop loss at $45. It then continues upward to point D, say in this case it rises to $63 a share, where we sell to take our profits before the stock drops again.
We can also have a bullish ABCD pattern. This is where the stock looks to rise.
In this case, we buy at point D. This can be done buying calls or going long on the stock.
When we see ABCD patterns, the lines AB and CD are known as the legs. The line BC is either called the correction or the retracement. A retracement is a temporary reversal of the stock price. In that case, the stock has an overall upward trend for the day. So, the retracement is seen as a temporary downturn that is going to reverse. A correction is a downturn of 10% or more in the price of the stock. A correction is an ideal time to buy a stock because odds are it’s going to go back up and possibly strongly so. In the second chart, at point D there has been a correction. In the first ABCD graph, we see a retracement, on the way to an overall upward trend.
Ideally, the lines AB and CD should be of equal length.
The Bull Flag
A bull flag is a strong upward trend in the stock. However, after shooting upward, the stock enters a phase of consolidation, when people slow down or stop buying, but before a new rise may begin. The “flagpole” is a steep rise in the price of the stock over a very short period. The “flag” is a period when the price is high but stays about the same. A bull flag is a symbol of a buying opportunity for a stock that has already shown a significant increase. You should set your desired profit, buy and then sell when it begins increasing again up to the point where you have set to take your profit. You should always include a stop-loss, a bull flag is no guarantee and the price might start dropping.
When there is a bull flag, it is bordered along the bottom by a level below which the stock is not dropping, known as the support. On the top, there is a level above which the stock is not rising. This is called resistance. Eventually, the stock is going to break out of the resistance so you want to buy before this happens, as the stock may see a rapid rise again. A bull flag may occur multiple times during the day as the stock trends upward.
The Bear Flag
A bear flag is equivalent to a bull flag but when a stock is tanking, so it represents opportunities to short the stock or buy puts. In this case, the stock will drop by a large amount over a short time. It’s going to have an upside-down flagpole, and then a flag at the bottom where the stock stays within a narrow range for a while, bounded by resistance and support. This is a buying opportunity if you are looking to short the stock so you can buy a put with an appropriate strike price. The hope here is that the stock will continue it’s a downward trend when it breaks out of the flag. It may do so rapidly and then hit another flag later in the trading day.
Reversals
A reversal is a major change in the direction of the price of the stock. So, the trend completely shifts and moves in the opposite direction. To look for reversals, look at the candlesticks on a stock market chart. The body of the candlesticks and its size relative to the previous (to the left) candlesticks is what is important. First, let’s consider a signal for a reversal where a declining stock price is going to be going up in the future. If the candlestick of the most recent time is larger and fully engulfs or covers the candlestick to the left. It’s the opposite color, i.e. a green candlestick following red candlesticks, this indicates a reversal of a downtrend into an increasing stock price. This is a good time to go long or buy calls.
On the other hand, let’s now consider the case where the stock price is going up, with multiple green candlesticks in a row. Then it is followed by an engulfing red candlestick. This indicates a reversal so we will expect the stock price to begin going down. That is, this is a point where we should short the stock, or if trading options invest in puts.
The larger the engulfing candlestick, the stronger the reversal signal is. That indicates that the change in direction has a significant conviction behind the reversal, which is the confidence of investors, larger volume and the price will change in larger amounts over short periods. If the wicks engulf the wicks of the previous period, that is an even stronger signal that a reversal is underway.
When using reversals as a trading strategy, you need a minimum of five candlesticks in a five-minute chart. Then look at the relative strength index, which helps you evaluate overbought or oversold stocks. The RSI ranges from 0-100. At the top of an uptrend, if the RSI is above 90 that indicates that the stock is overbought and is probably going to be heading into a downturn. On the other hand, if you are looking at the bottom of a downturn, if the RSI is 10 or below, this indicates that the stock is oversold. That could be a signal that is about to see a price increase.
When looking for reversals, indecision candlesticks can be important in combination with the other variables debated here. An indecision candlestick indicates neither an upturn nor a downturn. That is if you see a downturn followed by several indecision candlesticks, that could mean that the stock is about to turn upward again. Or vice versa – if an upturn is followed by several indecision candlesticks, that can indicate a reversal resulting in a downward trending stock price.
Looking at the wicks can be important as well. When the lower wick of the candlestick is longer, that may indicate that the price dropped throughout the candlestick, but the stock turned and was bought up. On the other hand, if the candlestick has a long wick at the top, that may indicate that the stock was bid up too much over the period. Traders lost interest and began selling off the stock.
At any time, there appears to be a reversal, a trend of indecision candles or stagnation represents a buying opportunity no matter which direction the stock may be trending. That is if you are in the midst of a downturn and the stock is moving sideways, then it may be a good time to go long on it or buy calls. The opposite is true if the stock is at the top of a potential reversal. If it’s moving sideways, it may be a good time to invest in puts. Keep in mind that this does not always work. The best indicator is whether or not a green (red) candlestick following a red (green) candlestick which engulfs the candlestick to the left is the best indicator of a coming reversal.
Moving Average
Another trading strategy that can be exploited is the moving average. This may help when a trader is looking for entry and exit points while trading. First, we will look at the simple moving average crossover strategy. Look at candlestick charts when considering moving averages with a two-minute interval.
You can include multiple moving averages in a chart with different periods. A faster-moving average on a chart is colored red and a slower moving average is colored green. A buy signal is a red line moving above the green line. That is, it breaks above the green line. A sell signal is when the green line is above the red line. If the lines are overlapping, then that means to wait. So, to profit, when the faster moving average tops the slower moving average, you go long, which means buy the stock or buy a call option. Then when the red line (or faster-moving average) goes below the slower moving average that is a sell signal. If you went long you sell your stock. It could also be an indication to buy puts.
A stop loss should be five or ten percent below the moving average line.
Solid profits can be realized when the stock breaks out high above the moving average. You can choose to take a half-position at this point, to lower your risk.