In the previous newsletter, we explored the process of trailing the stop loss for swing trades using the Supertrend indicator. We discussed how to set the pattern stop loss as the initial stop loss and progressively adjust it using the Supertrend. Additionally, we introduced two alternative methods for trailing a stop loss.

In this newsletter, we will focus on one of those methods: the 9-EMA Rule. This technique is particularly effective for trades on OHLC (Open-High-Low-Close) charts and can be applied across any timeframe. We will first break down the components of this method and then review some practical examples to illustrate its use.

What is the 9-EMA rule?

Swing trading involves holding positions for a duration ranging from a few days to a few weeks. In this strategy, trailing a stop loss is essential to exit at the first sign of a trend reversal. This is where the EMA (Exponential Moving Average) proves invaluable. The EMA is a type of moving average that assigns greater importance to recent price movements, allowing it to adapt more swiftly to current market conditions.

Setting the EMA period to 9 candles makes it an effective tool for trailing stop losses, as the 9 EMA closely tracks the price movement on OHLC charts. However, unlike the Supertrend indicator, the EMA’s value alone should not be used as an exit point. It’s important to account for the stock’s volatility, which is reflected in the wicks on OHLC charts. If the 9 EMA value is used as a trailing stop loss exit, there’s a risk of a false exit, where the price dips below the EMA line to form a wick but ultimately closes above it.

To address this, the 9-EMA rule incorporates a second component: the two-candle close. According to this rule, the price must first close below the EMA line. The trade is then exited only if the second candle also closes below the first candle's closing price (i.e., the candle that initially closed below the EMA). We exit the trade when the second candle closes below the first candle’s close, not just when it closes below the EMA line. This is because closing below the EMA line can sometimes give false signals. Waiting for the second candle to close below confirms the exit more reliably. It should be noted here that the two closes must be consecutive.

How to use the 9-EMA rule?

To apply the 9-EMA rule, create a scanner using any free online scanning tool. Set the condition so that today's candle (because we are using Daily Timeframe) closes below the 9-EMA line. Run this scanner on an end-of-day (EOD) basis across your current swing trade basket to identify potential stocks.

On the following day, monitor the market and wait until just before the close to confirm whether the trade is closing below the previous day's candle close.

For stop-loss management, start with the pattern stop-loss as your initial level. Once the 9-EMA line moves past this initial stop-loss level, begin trailing your stop-loss along the 9-EMA line.

In the previous newsletter of this mini-series on OHLC charts, we analyzed the charts of COCHINSHIP, POWERINDIA, and ANANTRAJ. The same examples are shown here.

There were cases where more than two trades had the same trailing stop loss exit, such as the exit for Trade 3 and Trade 4 in COCHINSHIP, and Trade 2 and Trade 3 in ANANTRAJ. Additionally, there were instances where the trailing stop loss of one trade became the entry point for the next. It's also worth noting that sometimes the price closed below the 9-EMA but did not close below it the following day, highlighting the effectiveness of the two-candle close method. The two-candle close made sure that the trade was continued for as long as possible.

This newsletter explored the effectiveness of 9-EMA rule as a tailing stop loss method. This rule is applicable only on OHLC charts. In the next newsletter, we will explore how EMA line can be used to trail the stop loss on Renko charts and PnF charts.

If you're new to trading, the TNT One membership is a great way to kickstart your journey. With access to all current and future courses, it offers valuable knowledge and practical techniques that will enhance your understanding of trading and boost your skills.

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