In the first part of our story, we discussed the Simple Moving Average (SMA) Projection line that showcased the SMA and a projection of the SMA in the next time step. From this, we could determine a little bit about volatility and also where the projections look like the current price action should be going.
I concluded my analysis of the SMA Projection as saying that I would not rely on it, but I think that I had spoken too soon. I performed more research on the idea and came up with another concept called the SMA Projection Trend, which is the same data, except it is instead represented as the difference between the current T0 projection and the most recent T-1 projection.
However, this will not be about the SMA Projection and SMA Projection Trend indicators. Instead, I have found more utility in the EMA Projection and Exponential Moving Average (EMA) Projection Trend indicators. The EMA is more responsive to immediate events and exponentially decays the more historic data to give a an average that is more biased towards recent data, which is important for traders that care about current price action.
Whether talking about the SMA or EMA Projection Trends, they both measure momentum, which also takes into account volatility. For example, looking at the next chart, you can see captured momentum soon after the RSI crossed into overbought territory.
To get a clearer picture, I have zoomed into the area of interest. For a 30 minute period, the RSI crossed into overbought territory before returning to normal. That was our first signal that we should begin paying attention for a good entrance, but we did not receive confirmation until three hours later that momentum was finally beginning to move downward.
Patience is key. The more confirmation signals you have, the more reliable your entrance.
In my opinion, we would have actually entered a short position three and a half hours after the RSI overbought signal, because we would have wanted to confirm that the close of the first downward momentum bar we saw actually closed down. Remember, patience is key, and before entering any position based on technical or fundamental data, acquiring a lot of confirming signals adds fuel to the fire for your entrance.
Use a critical eye. Nothing is guaranteed.
Combined with some other indicators, such as the ATR, RSI and perhaps the Bollinger bands if it suits you, the Projection Trend seems to be a pretty reliable detector. As a word of caution, however, you must look at the charts and these indicators with a critical eye, because unforeseen events can occur that lead them to lie to you. Therefore, always ensure you are paying attention to as much general information as you can.
To aid in preventing these pitfalls of unforeseen challenges, I recommend setting appropriate trailing stops. You can choose these to suit your own risk levels, but I would think the ATR can help you do this by looking at the total level of volatility over the last several bars of information. Perhaps you would want to do 2x ATR, or perhaps you would want to calculate the volatility through the Black-Scholes equation and use that to determine potential price movements. However you do it is an exercise left to the reader, but these are just some ideas.
Come back again as one more part to this series will be released that links to Happiness Enterprises’ github repo with these models in it. If you have Ninja Trader 8, you will be able to use them directly, and if not, well, you can at least translate the code to your own platform of choice.
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