If you don't at least take a quick glance at the above before reading on, it's likely I'll lose you...right about...NOW.
This is the journaling of my backtesing of Connie Brown's method (please refer to link above for detailed description of the said method). I'm doing this for the friend who sent me the link and also for my own learning purposes. I've not used the method to trade at all and I strongly advise those who intend to apply it in their trading to first do their own backtesting, then paper trade first before using it in real-money trades.
As Connie Brown's method requires trend confirmation before it can be used effectively, I've added these moving averages for trend determination: EMA 7 & EMA 21. I've decided on these numbers after testing out various other combinations of periods. Backtesting is done on the stock that I'm actively trading: GS.
If you're trading a different equity or instrument, you will have to play around with the number of periods, and also see if the EMA or SMA, or a combination, fits more with the price data of what you are trading. Which MA you use, and the number of periods used, will be based on such factors as the volatility of what you're trading, its trending characteristic, and your personal trading style.
The number of periods most commonly used are: 21, 50, 89, 150 and 200 days. Certain equities use periods of 70 and 100.
I've chosen EMAs and the periods 7 & 21 because I am a very short-term trader, and this setup's degree of sensitivity to signals suits my risk appetite.
I've also adjusted the oversold line for bearish trend to 20 from the 25 that Connie Brown uses, because when tested on GS, 25 sends premature exit signals too frequently. Based on my observation, divergences above the adjusted 20 line make better exits.
The following chart shows an example of how I MIGHT use Connie Brown's method:
In the RSI panel, you'll see various overbought and oversold lines. Ignore the 2 white lines representing 70 and 30. The ones we are looking at are:
For bullish trend - Blue solid line that represent the OVERBOUGHT line ; Red solid line for OVERSOLD
For Bearish trend - Blue DOTTED line that represents the OVERBOUGHT line; Red DOTTED line for OVERSOLD
Briefly on GS' movement prior to May 7: GS was trending down for 2 days on May 2 and May 5. On May 6, it climbed up to a high that's slightly higher than May 2's open, then took a slight dip but still closed above its open and near its high.
On May 7, the session opened with GS gapping up just a little from its previous day's close. As seen in the 5-minute chart above, GS's first move was a dip. The 2nd candle that I've labeled S1 seems like a good place to short the stock because:
1) RSI has crossed over the 50 overbought line (represented by the blue solid line in the RSI panel) from above
2) MA is seeing a bearish cross-over
3) MACD is also showing bearish cross-over and going into bearish region
However, I wouldn't enter a trade here for the follow reasons:
1) S1 sits on May 6's support - given GS' tendency to vacillate markedly in the first hour of the trading session, I'm not sure "down" is the direction it'll continue to take. The length of the bearish candle before S1 would have made me really uncomfortable as i would expect some profit taking following that.
2) To enter at S1, my stop loss would have to be at the high of the 1st candle of the session - the risk I would have to take is far too big for an unknown profit potential. Putting it in another way, the cost of this trade would be too high for me personally.
So much for today. Examples of 2 trades that I would enter will be shown in Part 2 of this topic.
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