Day Trading Tutorials
This second section of my day trading tutorials is on price indicators. I'll give you some day trading tips on how and how not to use some of the more popular indicators.
I will go ahead and tell you right from the start --- I'm not a big fan of price indicators, but I think at the very least, in these day trading tutorials I should introduce you to several well known indicators.
Price action and some help from volume is all you really need to make money day trading stocks. I do, however, feel that some indicators make useful day trading tools for scanning and screening for stocks that you can put on your watch list for the day.
I'm just going to give a basic introduction to several price indicators in this second day trading tutorial in case some of you might want to use them in programs such as TradeStation or NinjaTrader to create original stock scans. They can at the very least tell you when a stock is trending or when a stock is in a low volatility state. Just don't make the amateur mistake of thinking you can trade successfully with simple indicator or oscillator crossovers.
These day trading tutorials will not be going over the mathematical calculations of each price indicator. I don't want to bore you with all that stuff. There's plenty of resources on the internet if you need to look that up.
If you're going to use price indicators or oscillators to create scans and then trade off price action that's fine, just be aware that they have far too much lag to put you into profits by trading them directly.
So, here's a trading tip ....... don't waste any money or time using indicators for day trading signals!
BOLLINGER BANDS with BANDWIDTH
Bollinger Bands, created by John Bollinger, are standard deviation bands, one above and one below a moving average. The usual settings are 2 standard deviations and a 20 period simple moving average. Standard deviation is a statistical measure of volatility.
As a stock moves from periods of lower volatility to higher volatility, and then back to lower volatility, you will see the bands expand and contract. When the Bollinger Bands are relatively close together, that's telling you that the volatility of that stock is low. Later, I'll go into how you can use a low volatility periods to make money day trading stocks.
For now, I'd just like to point out how a day trader could possibly use Bollinger Bands when combined with another tool Bollinger created called BandWidth. Basically, this tool measures the relative distance between the two bands. You'll notice in the chart below, how periods of tight BandWidth always leads to periods of expansion. You don't know when or in which direction that expansion is coming, you just know that in the not too distant future, volatility will be on it's way. And you know what that means. It takes price movement to make money.
Ponder that concept for a moment........I know that will generate some ideas in your head. We'll go over that and more in later day trading tutorials.
You can find more detailed information on BandWidth in his excellent book "Bollinger on Bollinger Bands".
Here's another example of
Bollinger Bands with BandWidth.
AVERAGE TRUE RANGE (ATR)
Created by J. Welles Wilder, the ATR Indicator, also known as Average True Range, is a volatility indicator. I won't go into the calculations for the Average True Range (ATR) indicator, but I'll tell you it was originally created to capture gap or limit moves in daily commodity prices since the high-low range did not. Typically a 14 period is used in its calculation.
So, how can you use the ATR? Like the BandWidth Indicator above, I don't use the ATR indicator to enter trades, but it certainly can be used to create ideas for stock scans. Here's an idea that you can maybe expand upon.
Set the Average True Range Indicator to 1, so that it immediately tells you when a stock has a very narrow range bar (NRB). If you don't already know, the range of a bar is it's High minus its Low. Look for relatively narrow range bars. Why? Because NRB's are generally followed by bars with
wider ranges and wider range bars have more potential for profit.
I've highlighted areas on the ATR Indicator below, where the daily range of this stock is very narrow, compared to prior days. Notice how wider range bars immediately follow these NRBs.
Are you starting to catch on to a common theme in these Day Trading Tutorials, that maybe areas of low volatility are a good thing? I hope so.
Here's another example of
Average True Range.
One way to day trade stocks is to scan for stocks that are trending on a daily chart and then use multiple time frame analysis to enter the stock after a retracement/pullback, combined with a breakout on a lower time frame chart. More on that in my Day Trading Strategies page.
There's all kinds of ways to find stocks that are trending on a daily basis and scanning stocks with the ADX Indicator is just one of them.
High ADX readings do not tell you whether price is in an uptrend or downtrend, but of course you can determine that by just looking at the chart or using moving averages.
Divergence of price and the ADX Indicator can sometimes forecast a price decline, as in the stock chart below.
Probably the most popular of Welles Wilder's indicators is the Relative Strength Index, also known as the RSI Indicator. This is an overbought, oversold indicator, with a standard setting of 14 periods. The indicator ranges from 0 to 100. Overbought is at 70 and oversold is 30.
As with all overbought, oversold indicators and oscillators, newbies will try to trade these directly and will lose their shirt. Don't go down that road. There is no money to be made that way.
At the very least, please understand from these day trading tutorials, you will not become a successful day trader by simply trading overbought/oversold oscillators OR moving average crossovers. It just ain't gonna happen.
Another way newbies try to lose their money is by trading divergences. A divergence is simply when price moves in one direction and an indicator moves in the opposite direction. You are trading against the trend on that time frame! Don't do it.
Take a look at the following chart. This is what's going to happen most of the time trying to trade against the trend with RSI Indicator oversold or RSI divergence signals.
If you feel you must trade divergences, then at least trade reverse divergences. That way you'll be trading with the trend on that time frame.
Here's some examples of reverse divergence using the
Yet another contribution from Welles Wilder to technical trading, the Parabolic SAR is actually an always in, stop & reverse trading system. You are supposed to buy when price is above the SAR and sell when price is below. However, I would never use it this way.
Like simple moving average crossovers systems, the Parabolic SAR will work well in strong trending markets, but will fail miserably in range or whipsaw markets.
I wanted to introduce you to the Parabolic SAR strictly for the purpose of EXITS. Personally, I don't use it, but if you find yourself having trouble exiting your trades prematurely and
not letting your winners run, so that your day trading system can have a positive expectancy (expectancy will come later), maybe the Parabolic SAR can help you out.
Here's a chart of it being used with a non-standard setting to exit a breakout trade. In this example, the Parabolic SAR really lets the trade run it's course.
OK, one more price indicator and then later in my site we're going to move on to what I like.........price action breakouts!
As part of this day trading tutorial on price indicators, I'd like to make you aware that not all traders trade with the trend. There are some that trade with success using "countertrend" trading methods. What this means is that some day traders, like to step in front of a price trend, once they feel that it has extended far enough and bet that price will quickly pullback like a stretched rubber band.
Following, is one such generic concept, that you might want to investigate further.
Keltner Channel, well what do know, an indicator that wasn't made by Welles Wilder. This one is named after Chester Keltner. The Keltner Channel is made up of a simple moving average using the high, low and close divided by 3 and channel lines above and below.
Notice how all the highlighted areas above or below the channel, in the direction of the immediate trend, came back to touch the moving average. Looks tempting to trade this way doesn't it?
And, some traders do very well with their countertrend methods.
Just be aware when trading this way, that price can really run over you like a freight train. I mean fast!
I hope you found these day trading tutorials educational and they added to your knowledge base. Keep in mind that price indicators are mostly good for one thing, scanning stocks for opportunities and trade setups.
Because they are mathematically derived from price, they of course present lag, which makes them less than ideal for day trading decisions.
But don't just take my word for, prove it to yourself, by doing some simple backtesting.
Other day trading tutorials under different topic names are listed on the left side navigation bar buttons.
They present stock day trading concepts that will possibly change what you consider important about the different aspects of day trading methodology. I'll go ahead and give you a clue right now. Your setups for entry aren't as important as the position size of the trade.
Don't know what that is? Don't worry, I'll cover that and much more in other day trading tutorials.