Shorting Moving Average Pullbacks

TRADING SYSTEMS

Different Systems For Different Markets
Shorting Moving Average Pullbacks
by Steve Palmquist

Do you have a trading system that works well during declining markets? You can add the moving average short system to your toolbox.

A successful trader must have a variety of tools in his or her trading toolbox to match the various conditions he or she will encounter. The market has periods when it is trending up, trending down, and times when it is just basing. It is very difficult to find a system that works well in all three types of market conditions. A more fruitful approach is to use a different tool for each type of market. Using a system specifically designed for each type of market environment generally produces better results than trying to use one generic tool for all market conditions.
A DECLINING MARKET
The overall market direction is a powerful force that pushes most stocks in one direction. Just as it is difficult to swim against the tide, it is hard to make money in a declining market if your only tool was designed to find good long setups. When the market is declining, it is usually best to focus on shorts. One of the systems I use during market declines involves shorting pullbacks to a declining moving average. This technique is based on the observation that trends continue, and a pullback or retracement in the trend represents a low-risk (and well-defined) entry point.
The moving average short (MAS) system has five simple setup rules as outlined here. MAS candidates must:

Be in a downtrend

Have closed below the 35-day average in each of the last 15 sessions

Pulled back to within 1% of the 35-day average

Have an average daily volume above 200,000 shares and a price above $15

The stochastic indicator must be less than 80.

If the stock meets the setup rules today, then it triggers tomorrow if it moves below today's low. If the stock triggers, a short position is entered at the next day's open. For backtesting purposes, the position was held for three days, then covered at the open. As a variation on the fixed-time stop exit strategy used for backtesting, some traders may look to cover the short position if it approaches a key support level, continues down on declining volume, or closes below the lower Bollinger Band. If the position is declining on increasing volume, some traders will also give it more room to run.
...Continued in the September issue of Technical Analysis of STOCKS & COMMODITIES

Excerpted from an article originally published in the September 2005 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2005, Technical Analysis, Inc.

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