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One by one, we gather in groups… We think and act as one.
If you’re walking down Wall Street and suddenly see a crowd rushing your way, what would you do?
You’d join them, right?
That herd has to be running toward – or away – from something substantial, right?
And you can’t possibly miss it! So what do you do?
You react to the urgency of the situation, sending all rational thought right out the window. All of a sudden, the herd makes a mad dash for the exit doors, selling shares of Microsoft on no apparent news.
You – assuming the very worst – sell, too.
But wait a minute. Why are you selling? Do you even know? Or, are you are caught up in the herd?
Think about it. What if you could actually harness the energy of that irrational thought, the fear, the greed of the herd?
By relying on five key technical metrics, you actually can.
But first, think of a stock like a rubber band. That rubber band can only be pulled so far before it snaps back, right? Well, these five tools we’ll discuss let us know how far we can pull…
No. 1 – Bollinger Bands
When it comes to Bollinger Bands (plotted at standard deviation levels above and below moving averages, such as the 20-day moving average), stock prices tend to stay within the upper and lower bands.
So when the prices move to or above the upper Bollinger Band, we have an overbought trade. If prices move to or below the lower Bollinger Band, we have an oversold trade.
In short, Bollinger Bands let us know how far we can pull our rubber band. Here’s an example with Coca-Cola (KO). Notice what happens when the lower or upper Band is hit or penetrated.
No. 2 – Williams % Range
We never want to rely on a single indicator, such as Bollinger Bands to make stock buying or selling decisions, so we begin to confirm with others, such as Williams % Range. What’s interesting about Williams is its uncanny ability to signal reversals two days before reality strikes. Traders use the indicator to confirm. Let’s revisit Coke again.
When Williams reaches near zero, it’s overbought. When it reaches to - 100, it’s oversold. Look at what happens when the KO stock hits the upper Bollinger Band, as Williams reaches toward zero, the stock reverses about 80% of the time.
Now look at what happens to KO when the lower Bollinger Band is hit, and Williams % Range dips to -100.
Again, the stock reverses about 80% of the time.
No. 3 – Moving Average Convergence Divergence (MACD)
When it comes to MACD, we’re simply look for unsustainable pops above the mean, and drops below the mean. This is another indicator that can confirm potential pivots when used with Bollinger Bands and Williams % Range. It helps determine changes in strength, direction, and momentum.
The MACD turns two trend-following indicators, moving averages, into momentum oscillators simply by subtracting the longer moving average from the shorter moving average. It fluctuates above and below the zero line as the moving averages converge, cross and diverge. Traders can look for signal line crossovers, centerline crossovers and divergences to generate signals.
No. 4 – Relative Strength (RSI)
We can use RSI to confirm other indicators above.
When RSI moves to or above the 70-line, we have an overbought condition. When RSI moves to or below the 30-line, we have an oversold condition.
In short, it’s a momentum oscillator that measures speed and change of price movements.
When used with other indicators, it is a powerful momentum tool.
No. 5 – Money Flow (MFI)
Money flow is another oscillator that uses price and volume to measure the strength of buying and selling pressure. We can also use MFI to confirm the other four momentum indicators above. When MFI moves to or above its 80-line, we have an overbought condition. When MFI moves to or below its 20-line, we have an oversold situation.
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