4 Ways to Confirm your Trade Entries Using Technical Analysis

I was working with one of my mentees this week in a coaching session on Technical Analysis and he was so excited about using what he learned from our previous session on breakout and reversal patterns that he immediately applied what he learned in a couple of stock trades. The first one worked out really well for him and it was a profitable trade. However, the second trade he made turned out to be based on a false breakout and he closed the trade for a small loss. If you trade actively in the market, this is going to happen. There is no trading system that offers 100% guarantee of profit. Our goal as traders is to make trades that have a high probability of resulting in profit and to win trades consistently in greater numbers than those that result in a loss. So, we spent much of our coaching session discussing the idea of confirmation.

When we see a technical trigger for entry into a trade, whether it be a breakout or reversal pattern, a moving average crossover, or something else, as successful traders we want to look for other technical factors that tell the same story that we are seeing in the original trigger. Let’s look at an example in the chart below. Let’s say that a stock on our watch list is in a consolidation pattern like a descending wedge. We see a breakout to the downside. We want to look for confirmation of the pattern breakdown with other technical indicators. In this case, we see that the downward price action is confirmed with higher volume.

Here are four ways you can look for confirmation of your position entry decisions using Technical Analysis. Use these in combination with each other to determine whether they are telling a consistent story:

  1. Candlestick pattern breakouts and reversals - many times, as in the example above, your position entry trigger may be based on a break above a resistance level or a break below a support level. Breakouts from consolidation patterns like rectangles, triangles, wedges, and flags are extremely useful in identifying entry points for profitable trades. However, as we’ve discussed, these triggers aren’t reliable in and of themselves. Look for confirmation either from a second day follow through or through other technical indicators.

  2. Changes in Volume - many traders use volume, or changes in volume, to confirm changes in price action. In combination with candlestick pattern breakouts and reversals, changes in volume can be meaningful in assessing whether the momentum discovered can sustain a continued move for a profitable trade.

  3. Moving Averages - Moving averages are used by many traders to confirm price trends, identify areas of support and resistance, as well as indicating points of entry and exit from positions. Many traders look for moving averages crossovers where price crosses a moving average or when the moving averages themselves cross each other.

  4. Lower Studies - There are many studies technicians use to validate price action. There are actually way too many to list here. However, some of the more common studies to help confirm price action are the Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI), and Average Directional Index (ADX). I encourage you to read about these studies using the links provided.

Each trader is different regarding the criteria they look for and how they confirm their position entry rules. In my Impulse trading strategy, I look for two additional confirmation signals to confirm my original trigger. Most often, my original trigger is a crossover of the 5 and 13 day Exponential Moving Averages (EMA). In this case, I am looking for stocks where on the day of entry, they are showing upward momentum indicated by the 5-day EMA crossing above the 13-day EMA. This happens often, sometimes within days to weeks. Therefore, I need confirmation that the momentum is going to follow through and not be short-lived. For confirmation, I want to see the RSI above 50 along with a positive crossover in the MACD. There are other criteria I consider as well. However, these are the core three things I am looking for.

It took me a long time to hone in on these three criteria and I am still refining my technique and timing. As I mentioned before, this is not a guarantee by any means that if you adopt this criteria, you’ll have successful trades. I’m simply sharing what I do. Do your own research. Backtest your strategies and practice in simulated trading environments before building a trading system of your own. If you are looking for some support as you learn these elements of technical analysis, I go over all four of these elements in detail during my Technical Analysis coaching.

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