The Pattern Trapper Approach To Short-Term Trading
Unlocking The Mystery Of Market Behavior

Plotting 5, 15, and 30 minute 20EMAs

Although the techniques discussed in this course are just as effective in any timeframe in any freely-traded, liquid market, the trading methodology taught by The Pattern Trapper generally emphasizes the shorter-term timeframes: anywhere from intraday trades to multi-day swing trades The five minute chart is normally used as our principle intraday trading timeframe with occasional references to other periods when market conditions warrant. For this reason, the 5 min. 20EMA is our most frequently referenced moving average. However, it is very helpful to also plot both the 15 min. and 30 min. 20EMAs on the same 5 minute chart. This is accomplished by plotting the following values.

5 min. 20EMA - plot a 20 period EMA.
15 min. 20EMA - plot a 60 period EMA (15/5x20)
30 min. 20EMA - plot a 120 period EMA (30/5x20)

It must be realized that the values arrived at using this technique do not plot an exact and precise representation of the corresponding 15 and 30 minute 20EMAs, but for purposes of identifying potential support and resistance levels, you will find it quite useful.

 

20 Period EMA Support & Resistance Levels

For the intraday/multi-day swing trading methods advocated here, it is recommended that the trader regularly monitor the 20 period EMA in the 5, 15, 30, 60, and 120 minute timeframes. Although most of the charts referenced throughout this course will depict only the 5, 15, and 30 minute 20EMAs, it is important to realize that the 20EMA is often a significant reference point in all timeframes. It is even a good idea to keep tabs on its position relative to current price in both daily and weekly timeframes, especially when multi-day swing trades are being considered.

Under normal market circumstances (essentially, anything other than news-driven impulse thrusts), the 20 period EMA is used as we would any other potential support or resistance level. In congested, trading range market conditions, these levels can be violated rather easily with price casually meandering back and forth across our 20EMAs. Under this situation, the 20EMA means little as a potential S&R; level. But, we try to avoid participating in these market conditions anyhow - there's no sense in taking unnecessary risk when the market is this ambivalent. However, when price starts trending, the 20EMA can be an invaluable aid in determining appropriate areas in which to take action either by establishing new positions . . . or baling out of existing ones.

20 Period EMA & Trend Reversal Participation

One of the more frequent uses of this indicator comes into play after we've received a Trend Continuation Pattern Signal (chart above right). This category of Pattern Signals suggests that the trend established in the previous afternoon of trading is highly likely to continue on into the next day. Once a Trend Continuation Pattern Signal fires, we are on the lookout for any intraday retracement which takes price back towards a likely support (if in an uptrend) or resistance (if in a downtrend). The first level of support or resistance encountered is likely to be that of the 5 minute 20EMA, the 15 minute 20EMA, or the 30 minute 20EMA. It is important to keep an eye on these levels when we are expecting trend continuation. Once a trend has been established, it is very often the case that one of these levels (most often the 5 min. 20EMA) will do an excellent job of keeping the price action contained.

The 20 period EMA also comes into play when we've had a Pattern Signal fired which indicates a likely reversal in the multi-day trend (chart at right). Taking advantage of these kind of expected trend reversals is always a bit tricky. The trader never really knows if the most recent pivot extreme is truly the last one until the new trend direction has already been established. By using Oscillator Divergence and Reversal Pattern techniques as discussed later on in the course, the truly aggressive trader can try to catch these turns as they happen. But more conservative and beginning traders are better off simply allowing the turn to happen without their participation, and then attempting to get in on the retracement. The 20 period EMA is an excellent tool for gauging the degree of retracement and likely return to the new trend move.

20 Period EMA and News-Driven Price Thrusts

The 20 period EMA can also come into play on those days in which we expect large news-driven price thrusts such as often occur in the T-Bonds on the first Friday of every month (chart at right). The employment reports released on this day often cause severe price reaction as a result of their perceived effect on future interest rates. As a general practice, the trading tactics advocated by The Pattern Trapper discourage open positions during the release of such important numbers. Any attempt to pick the correct breakout direction ahead of the release is largely a matter of chance. When one considers transaction costs and the large slippage that is usually involved in trading during those kind of fast market conditions, 50/50 odds are best walked away from. We can trade with much higher probabilities on our side by waiting the 5 or 10 minutes that it normally takes for the initial trading hysteria to die down.

A more appropriate strategy involves exercising a little patience. Let the market make its initial move without you, and then look for opportunities to participate. Waiting until the initial move is over means that the trader will avoid jumping into the middle of what is typically very fast market conditions where large slippage is the norm and wide stop placement is a necessity. On the other hand, the trader who steps aside until the market frenzy is over is better able to evaluate their options and make better thought-out decisions.

The strong impulse thrust that often happens after such events are usually the beginning statement in a new trend move. Sooner or later, such thrusts will experience some sort of retracement before an advance of significance can take hold. Again, the 20 period EMA is an excellent tool for gauging the degree of retracement and likely return to the trend. There are other price behaviors that we use to trigger actual entry (discussed later in the course), but, for now, it is only important that we realize how significant a role the 20EMA plays in determining likely support or resistance, and in deciding the most appropriate time to jump on board. Sometimes, you'll miss out on the big hero moves using this technique, but you trade with better odds in your favor, and with considerably decreased risk.

As stated earlier, the "dynamic" characteristics of the 20 period EMA is what makes the indicator such an important tool. It's ability to react in accordance to more immediate changes in the market environment make it a valuable aid in creating structure out of essentially unstructured events. Later on in the course we will explain additional ways of using it for trade entry, stop placement, and in determining appropriate exit points.