Upbeat music plays throughout.
Animation: A stock chart using candlestick patterns shows a price that has rallied but has recently pulled back. A line is drawn from the most recent high, slanting lower. Then line is redrawn with a steeper slope.
Narrator: When trading bull flags, it can be difficult to know where to draw the lines. Should it go here or here? Like most price patterns, bull flags are up to the eye of the beholder. I'm David Bruner here on the trade desk at Schwab. I'm going to show you a couple of indicators that can reduce the subjectivity of identifying the trend and the entry and exit signals.
On-screen text: Bull flat steps. 1. Identify the trend. 2. Identify the entry. 3. Identify the exit.
Narrator: Today, we're going to be looking at a bull flag trend, and we're going to be using our indicators such as the RSI and moving averages to help determine that bullish trend as well as our entry and exit signals.
Let's jump over to thinkorswim®. For our example, let's use Royal Gold (RGLD). Remember, this is just an example and not a recommendation. The combination of indicators hasn't been back tested and there's no guarantee of profitability.
The first indicator is a moving average to help identify the trend. Technicians usually start with the trend and bull flags are traded on bullish or up trending stocks. Identifying higher lows and higher highs is the subjective way to identify the trend. But in this example, we'll say we have an uptrend when the price is above the moving average and the line is pointing higher.
Animation: From the Charts tab on the thinkorswim platform, the beaker icon is selected and the Edit Studies and Strategies window appears. SIMPL is typed in the dialog box and list of studies is created. Simple Moving Average is selected from the list by double clicking on the study.
Narrator: So now let's set our first simple moving average. We'll go up to the beaker to open our studies, and I'm going to add the simple moving average here. And click on the gear to change our length to 50 days and click Apply, and OK.
Identifying an uptrend even with the moving average can still be a little subjective because many traders will want to know when exactly a moving average is pointing up versus a reaction to price noise. You'll have to decide for yourself how much is enough to say that it's bullish. For example, here I'm going to say as long as it's neutral two up and the price is over, the moving average, that will be enough for us. RGLD's 50-day moving average turned up around the first week of March.
Technicians may argue what constitutes a flag pattern, but generally they are those downswings or pauses that take place in a trend before the price moves higher. Commonly, traders will draw a resistance line to identify the flag and create an entry signal when it's broken. Drawing the resistance line is also subjective, so we can use a shorter moving average to provide that signal.
Animation: The eight-day moving average is added to the chart by selecting the beaker icon, searching for simple moving average, double clicking the study, selecting the gear icon to edit the study, and changing the length of the moving average to eight. The color of the eight-day moving average was also changed to yellow. The study is added by and selecting Apply and OK.
Narrator: I'll at an eight-day moving average as the primary entry signal here. Consider going long when the price breaks above that eight-day average.
No moving average will work for every stock. Some stocks may test the five-day or a 10-day moving average for its upswings but try a few for yourself and figure out what works best for you. An eight-day does split the difference between these moving averages and some traders like an eight day because it's a Fibonacci number. So let's use that today.
So, if we zoom in here, we can see that RGLD broke above that eight-day moving average back on April 9.
Next, the RSI will be our confirmation signal. The RSI or Relative Strength Index is an oscillator that tracks price momentum. When the RSI line is rising, the price has bullish momentum.
Animation: The RSI is added to the chart by selecting the beaker icon, search for RSI, and double clicking the study, and selecting Apply and OK.
Narrator: On our chart, now we're going to add the RSI.
When the price breaks above the eight-day moving average, we'll look for the RSI to come out of the lower reversal zone and create a hinge. A hinge occurs when the RSI line turns bullish between these reversal zones. Many technicians consider a hinge to be a good signal in uptrending stocks because it suggests stronger price momentum.
So it looks like the bears weren't able to push the RSI line to the lower reversal zone, so the bulls appear to have the momentum.
The RSI confirms our eight-day crossover signal with this bullish hinge. Let's say we bought the stock at the close for $164.74.
Because swing trading often takes place in a tight window, a quick exit may be needed to maximize the gains. Therefore, we may choose to put this trade on a short leash. The exit we'll use here is to close. When the price breaks below that eight-day moving average.
We can still get back in if a new entry signal appears, we don't just have to treat the stock as a one and done event. Be careful though, depending on your broker and the type of vehicle you're using, this could result in higher trading costs.
On-screen text: Exit: $181.35. Entry $164.74. Gain: $16.61.
Narrator: On April 22, the stock closed below that eight-day moving average. Let's say we sold on the close at $181.35.
Moving averages in the RSI can be helpful tools to reducing uncertainty around trading signals. Feel free to mix in with whatever else you're using when you're trading to complement your strategy. Experiment with these tools using paperMoney to find a mix that works for you.
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