Market Models

I mentioned previously the topic of using market models.

A market model in simple terms utilizes three simple moving averages of varied time frames to help determine the current disposition of current prices to historical prices.

For my market model, I prefer to use the 8, 13 and 21. These have specific meaning aside from being Fibonacci numbers. The strongest meaning is hidden in the 21 is that there are 21 days in the average business month.

Above is the DJIA as of January 12, 2021.

The general concept is only take LONG trades when prices are above the 21 MA and short when below the 21 MA.

Along with the above general concept, the other two moving averages provide information regarding when to move in/out of the stock.

The 8 moving average behaves similar to a speedometer. While “trending” up the 8 MA should be following near the low of the bar. When a price closes below the 8 MA and still above the 13, this is a indication of slowing occurring in the prices.

The 13 moving average behaves similar to a smart brake indicator. You know the type in more modern cars that warns you something is in your way and starts to apply the brakes for you. Closing prices below the 8 and 13 MA are indicators of consolidation beginning/trend change.

It is generally at this point that locking in profit from a long would be considered.

A close below all three would then be considered a trend change.

Entering back into a stock would be considered once the prices are back above the 8 MA.

However – like with all rules, there is an exception. That exception is consolidation.

In a point of consolidation, you take the FIRST signal generated. You ignore every signal from that point on except for the signal generated by violation of the consolidation levels.

If prices enter into consolidation, close before the 13 for the first time, you take that signal. If the prices a few days later close below the 21 (but are still in consolidation), you do not take a short. The prices are still consolidation and the moving averages are catching up with the prices.

Should in the above example, a few days later, the close break above the consolidation zone. This is a consolidation buy signal and would be taken. Chances are that the price is also above all three moving averages.

Again, in the above example, a few days later, the close break below the consolidation zone. This is a consolidation short signal and would be taken. Again, the chance that the price is also below all three moving averages is strong.

Also, please note in the above, it is stated that the “CLOSE” is out of the consolidation. Prices have a tendency to move above/below consolidation and then return the same day. You want confirmation the consolidation is finished. This generally is done with a close.

Above is Under Armour (UA), on January 12, 2021 the price broke through and secured a close above the consolidation zone.

Another fairly decent rule is a the four day rule.

IF close is HIGHER than the previous 4 days HIGHS, prices will move HIGHER.

IF close is LOWER than the previous 4 days LOWS, prices will move LOWER.

The above rule can be applied to both trending and consolidation prices.

I am not the only individual to use market models. I have spotted market models in many individuals YouTube videos and while they don’t overtly discuss it, they may also not be fully aware of what they are doing.

I have noticed a large variant of time periods. The most notable is from Dr. Chris Kacher who worked with William O’Neil. Dr. Kacher prefers to use a 20, 50, 200 combination.

Above is an example of Under Armour (UA) January 12, 2021 using the 20, 50 and 200 MA.

The rules which are established for this method also include volume. The break outs must be accompanied by increased volume from the previous day.

Dr. Kacher has been involved in the markets longer than I have and has made substantially more money than I have. So, if you would like to learn more about the strategy Dr. Kacher uses, google is a useful tool or “Trade Like an O’Neil Disciple” by Gil Morales & Dr. Chris Kacher would be a better tool.

In regards to my system, I prefer to use the 21 MA personally, one of the reasons is that I can quickly detect stalls that are ready to occur in the price action.

I have found that when you take the difference between the close and the 21 MA and divide that by the average period trade range, that anything 3x signals potential stalls coming in. Prices tend to want to be around their averages.

No matter which time frames you utilize, ensure that they are properly scaled away so that they fit your trading strategy.

Some trades will use the prices of the middle moving average as the “stop” and this way they let their winners “run”.

The concept of using the 13 MA or middle MA for a stop is a very good idea (except in consolidation) again. Don’t enter into a trade when prices are in consolidation. It is a slow and painful process.

This system for the most part is useful across all time frames above 4 hours. I have not back tested this against anything lower than 4 hours.

To get an idea of how this can assist trading, I have a two MA strategy that shows a win/loss ratio for the DJIA if you had traded based on the two MA strategy. While I do need to generate a similar for this 3 MA strategy, you can get an idea of how efficient it is by following this LINK.