Three-Day EMA Features

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1. Defines trend direction

2. Shows strength of trend

3. Confirms high points and low points by shape of the moving

average (slope)

4. Confirms major chart patterns, making them easier to see

5. Assists in the placement of short-term stops or exits

Now let us examine the use of the three-day EMA on a

microlevel. In Figure 5.14, you see the three-day EMA over a threemonth

period of time. One of the important points to note when

looking at this chart is the relative position of the dose above and

below the three-day EMA. In most cases of trending stocks, if you

intend to go long, the stock you will want to see will have closes

above the moving average. When you are planning to short, you

look for a topping formation and for closes to be lower on the daily

price bar or below the moving average.

The three-day EMA can be used to place stops in two ways.

First, you can use the three-day EMA to confirm long and short parabolic

stop and reversal (SAR) points. Figure 5.15 shows how well the two work together to keep you in the current long and short

trend. The dotted points represent the suggested stop placement

for parabolic SAR. The solid dark line represents the three-day EMA.

Note that this chart covers one year of daily high, low, open, and

close information for Micron Technologies.

Currently, Disney (symbol DIS) is not typically a volatile momentum

stock. This is a perfect test of the three-day moving average

stop placement methodology. Figure 5.16 shows a period of

price consolidation in June, a decline into August, followed by an

uptrend and a sell-off into August 31. In June, you see how the dark

three-day EMA rounds out at the bottoms and results in sharp

points at tops. When the stock trends, the same signature tends to

repeat itself. This signature addresses the momentum at tops and

bottoms and gives you an excellent idea of the direction of the trend

and its strength. High-probability, profitability traders do not usually

trade consolidation areas. They wait until a trend develops. In

early July, the third top in the consolidation formed and then began

a strong downtrend. Note that the dotted 12-day EMA is above the

3-day EMA. When you are short, you can use the 12-day EMA to

place your exit stops. There are only two rules. First, cover your

short position when the 12-day EMA crosses under the 3-day EMA.

Second, cover your position when the close is above the 12-day

EMA. Figure 5.16 also shows the 50-day EMA on the chart, which

identifies intermediate trend. You will note that the trend has for

most of this time period been bearish. Using the 50-day EMA in combination

with the 12- and 3-day EMAs gives you a better picture of

the major trend and whether it is bullish or bearish.

At the end of July 27, a top forms, and the next day price closes

below the intersection of the 3- and 12-day EMAs. From that point on

until a bottom is formed, the closes are toward the low of the daily

price bar and below the three-day EMA. On August 10, the close begins to reverse, closing above the three-day EMA and alerting you to a possible

change in trend. August 13 shows a break above the 3- and 12-day

EMAs, with the close above the 12-day EMA. If you were still short, you

would cover your position at this point and take your profit.