On Friday’s job report, the futures session experienced a high speed negative reaction. It turned out, this was a powerful bullish trading opportunity. Markets reversed, and by the end of the day, the QQQ was up +1.68%.
How could you have predicted this?!
Answer: the moving average crossover.
One highly successful strategy according to years of backtests utilizes the cross between the 3 and 8 period moving averages to determine the trading trend. The strategy is simple – the trend is bearish when the short-term 3-period moving average crosses below the 8. The trend is bullish when the 3-period moving average crosses above the 8.
For day trading, I like to use the 15 minute candles to prevent false signals as much as possible, and I really only like to use this strategy on days where there is a market-moving catalyst. With CPI coming up this Thursday, I thought it would be important to bring this up. Let’s take a look at how it worked out over the past two days using the QQQ.
I’ll be honest with you, through the volatility we’ve seen in 2023, this strategy has been my bread and butter. It doesn’t always work, but in the example above, it worked in every single instance. The initial bearish cross lower on the 5th led to a move of about $2.50 in our direction. Then, the cross higher mid-day led to a similarly sized upwards move in our favor. Finally, during the premarket, the QQQ crossed back lower ahead of Friday’s report, which saw a massive drawdown. Using this strategy, you would have caught a portion of that lower move before reversing into positive when the final bullish cross took place with the QQQ still in red territory for a final move in our favor of nearly $7.
As we said, this strategy won’t always work – no strategy is 100% effective. But as someone who uses this strategy on a regular basis, it is among my favorite tools to make short-term trades. When utilizing options, I like to keep my strikes near-dated and in-the-money to negate some theta decay while retaining as much leverage as possible. Additionally, when using this strategy, it’s crucial to stay nearby to your trading platform, and to set technical alerts for these crossovers. With the right set-up and platform, you can instruct your brokerage to automatically close or open specific positions upon crossovers – which is very important to avoid getting stuck on the wrong side of a powerful trend reversal like the one we saw on Friday.
As an update from the chart posted above, we marked additional areas where the signal has crossed over the last several days below.
As we said above, an important note here is that it’s best to enter the trade on the cross when this happens, rather than trying to jump in in the middle. Additionally, if you enter, and the signals cross back over, don’t be afraid to reverse your position or to cut the position and wait for another entry. This is the type of strategy that requires you to be paying close attention and staying ready for the crossovers to happen – but when they do, they can be incredibly powerful trading signals.
Additionally, if you’re in a position that’s going in your favor, and you’ve made some profit, you might want to set a profit target ahead of time you’ll be comfortable selling at rather than waiting for the moving averages to cross back over and issue you a close signal. There’s nothing wrong with capturing profit when it’s right in front of you – and a strategy like this can lead to more consistency. After all – setting profit targets before you enter a trade is one of the things we preach often here at Market Rebellion!
How to Use This Strategy with Options
This guide isn’t over – there’s one more crucial piece here. That piece: options. Think options are just for high-stakes gamblers? Think again.
If you were trading this strategy with shares, you would be tying up a massive amount of cash in return for a possible 1.9% return like the one we saw above. Options allow you to even out that risk/reward ratio, at a lower cost, while limiting your overall risk and amplifying your potential profit.
Using a simple in-the-money approach, we can simulate ownership of 100 shares of stock while only risking a fraction of the price. And since this strategy focuses on short-term movements, that means options are among the most perfect tools to do the job.
Here’s another instance of the strategy, and a look at how you could have used options to capitalize:
Early into the trading session on Monday morning, things looked like they were trending lower. The QQQ had fallen more than half a percent. But then, something interesting happened.
The 3 and 8 period moving averages inverted, even though the present candle was red. That was your one and only sign that a reversal was about to take place – and it did. When you saw this crossover, you could have considered using options to capitalize on the potential bullish reversal. To do that, with the $QQQ at $362.55, you might grab an in-the-money call option at the $360 strike for roughly $2.75 expiring the same day. Grabbing an in-the-money option with little-remaining theta allows you to pay as little as possible for up to 100 shares of leverage. For the same leverage using shares, it would cost you more than $35,000. Instead, you’re only risking less than 1% of that. Let’s see how it played out:
From the moving average crossover to the present price, the stock moved +1.20% in your favor. And that $360 strike option?
By the same time, those options traded for $6.90 – a gain of more than 100% in just a few hours.
Heading into this week’s CPI, consider adding these moving averages to your chart to make more informed trades.
Curious how Market Rebellion’s professional traders use more options strategies like this every day? We’ve been working for over a year on our newest book, “It’s NOT an Option” which focuses on the wide plethora of things you can do with options that you can’t do with shares. Using the link below, for a limited time, access the first chapter for free.