In today’s discussion, we will take a look at one indicator that hugs the market like a rubber band around your wrist. The further it moves away from the underlying market, the harder it usually snaps back.
Many traders use moving averages to make decisions about the direction of the markets they are trading. Is the market on an uptrend, downtrend or is it moving sideways? When you look at moving averages, the ones most commonly used by traders are:
- Simple Moving Averages (SMA) and
- Exponential Moving Averages (EMA)
For a concise explanation about the differences between SMAs and EMAs, which are often used in conjunction with each other, click here (Investopedia.com)
Renowned author of multiple trading books and speaker Stephen Bigalow uses moving average and candlestick patterns to teach traders how to identify setup opportunities in the markets. And his favorite indicators is the 8 EMA, which he calls the “T-Line”.
The 8 EMA is technically a lagging indicator, but it can have some value as a future predictor of price movement.
- If the price of an asset is hugging or touching the 8 EMA above the line, you are on an uptrend.
- If the price of an asset is hugging or touching the 8 EMA below the line, you are on a downtrend.
- If the price gaps and moves upward and well above the 8 EMA, a correction or reversal to the downside is imminent.
- If the price gaps and moves downward well below 8 EMA, a correction or reversal to the upside is imminent.
In this discussion, we will take a look at the rubber band effect, when the market gaps away from the T-Line.
Let’s take a look at the 8 EMA on a 15-minute chart of the US 500 Futures from February 21-24:
The only indicator plotted on this chart is the T-Line, shown in purple. The purple arrows show areas on the chart where the market gapped more than 30 ticks away from the T-Line. You will notice that if the market gaps sharply away from the T-Line, it snaps back very quickly.
In the Chart below, we will look at trade setup opportunities around the 11am-1pm time frame on February 23 (circled in red, above).
At 11am, the T-Line was at 2360.1, and the 15-minute candlestick gapped all the way down to 2355.1, for a full 5 point, or 50 Tick move downward. That’s a sharp move way from the T-Line. Just like the rubber band, the market snapped back and climbed 50 Ticks back upward within 30 minutes, breaking slightly through the T-Line.
So, how do you trade the “rubber band” effect of the T-line?
At the close of the 11am candlestick, you could have chosen an At-The-Money (ATM) Nadex spread, where the risk and reward is evenly distributed around the 2355 price. Since the market had already gapped significantly away from the T-Line, then you would consider being a buyer on the anticipation of the market snapping back to the T-Line.
- Entry Price: Choose an Entry Target at 2355.5. if possible
- Mental Stop/Loss: Consider Exiting the trade if the Market moves 25 Ticks against me, at 2353
- Mental Take Profit Target: If the Market returns back and touches the T-Line at 2359.6, for a 40-Tick gain or better, or $40 per contract traded (exchange fees not included).
Nadex Binary Options
If you chose Nadex Intraday 2-Hour Binary contracts (12 pm or 1 pm exiry), then the strike prices are set at 1.5 point intervals. Depending on your risk-reward preferences, you could choose from the following contracts:
- In-The-Money (ITM) Binary BUY at the first strike below 2355.5. You will assume a higher risk premium on this trade, since your probability of a true statement is greater.
- At-The-Money (ATM) Binary Buy at the first strike price at or above 2355.5. Your risk will be roughly $50 for a $50 reward per contract traded.
- Out-Of-The-Money (OTM) Binary Buy at the next strike above the ATM strike. Your risk premium will be lower on this lower probability trade.
In this example, since the market had moved up 4 full points by the 12 pm expiry, and 7 points by 1 pm expiry from the 2355.5 reversal at 11 am, then the ATM, ITM and OTM trades would have all expired true.
If you plot the 8 EMA (T-Line) on your Nadex charts, or any other charting software, you will see that it behaves the same on any market and on any time-frame.