If you’ve read our blog post about the N-day high/low alert, you know what a breakout is and how to trade it, as well as how to set up an alert to be the first to know about a breakout. If you haven’t yet, be sure to check it out.
But it’s not always that simple and that alert can fail to spot a breakout in some market conditions. Let’s start by establishing the three fundamental market regimes (types of conditions).
First, there’s the sideways market (sometimes called “sideways trend”, even though the price is not trending, or changing, in the mathematical sense), which is said to occur when price stays within some constant support and resistance levels. You know all about this regime if you read the previous blog post, and you know that when the price sets a new record outside the support/resistance levels, this signifies a breakout and usually leads to a move in the corresponding direction.
Then there’s the trending market, when the price is slowly but surely climbs or falls. A market with an uptrend is referred to as a “bull” market, and a market with a downtrend is called a “bear” market, with people preferring to trade each type calling themselves “bulls” and “bears” respectively. Support and resistance apply here as well, but in this case, they are not hard numbers, but slanted lines that correspond to the overall trend.
N-day high/low alert will not be helpful in this case, because it cannot adjust its threshold to the ever-climbing support and resistance levels.
PsyQuation got you covered here with our Moving Average Breach alert. This alert is triggered when an instrument crosses its Moving Average line, or MA for short. Moving average is a fundamental tool in every trader’s arsenal, it allows you to determine the price’s position relative to the overall trend. The math is very basic: look at the previous N closing prices, and average them, where N is the lookback window size. That’s it. The idea behind it is that it smoothes out the instrument’s volatility, tripping the price action down to just the trend.
When an instrument breaks through its MA line, it often means that it is outpacing its current trend and is on its way towards a breakout. Breakouts are a great trading opportunity, because they often lead to rallies, or big moves, as explained in our previous blog.
The lookback window size determines how responsive the moving average is to the price. A smaller window follows the price more closely, but leaves more noise and can lead to false positives. A longer window will get rid of the noise and show just the trend but can lag behind too much, which may lead to lost opportunities. There is not an easy rule of thumb to be used when picking the window size, but the most important factor is volatility, or how much the price changes – if the price is hectic and oscillates a lot, it’s better to pick a bigger window to filter out this noise and get to the trend. If a symbol is not volatile at all, then a shorter window will help you be the first to the action when a breakout is imminent. Try different parameters to see what works for each symbol.
You don’t have to wait for an alert to experiment with the window size – you can also take advantage of the probability table tool to help you tune the alert parameters. Simply go to the tool page, pick the instrument you are interested in, and play around with the window size to see which one picks out the most breakouts without generating too many false positives.
We provide two methods of calculating the moving average to choose from: simple moving average (SMA) or exponential moving average (EMA). EMA is slightly more complex mathematically and has the advantage of giving more weight to recent days as opposed to those further in the past, which means it will react to a change in the trend faster. But it will also be more prone to volatility spikes and can result in more false positives. Learn more about the difference between SMA and EMA in our next blog, which covers the Moving Average Cross alert.
For a detailed tutorial on setting up and using the market alerts, as well as picking the right parameters, check out our tutorial.