Trading with stage analysis, the Stan Weinstein way

Stage analysis trading strategy is a relatively popular trend trading strategy that was discussed in detail by Stan Weinstein, in the book, Secrets for Profiting in Bull and Bear markets. While the basic principle of trading with stage analysis is merely following the trend, Stan Weinstein gives a more structural approach to this trading strategy.

According to Weinstein, stage analysis uses chart patterns in order to derive the four stages in a security’s price. Once the stages are determined, there are specific guidelines that determine when to buy and sell. Stage analysis was initially described for the stock markets, but could very well be used for the forex markets as well. With stage analysis, traders can hold on to positions and helps to enter the trend at a relatively early stage.

Stage 1 – The basing stage

In this phase, the security is trading flat with no clear trend being established. Many could view this stage 1 phase as an accumulation phase. The sideways pattern is usually formed after prices have fallen or declined significantly in the previous stage (Stage 4).

In Stage 1, traders are recommended to make a watch list, for the potential securities that might breakout and advance to stage 2. Increase in volume during the stage 1 is required as a filter to gauge the effectiveness of the breakout. Volume initially declines once prices move into stage 1 and slowly start to build up ahead of the breakout.

Stage 2 – The advancing stage

In this stage, the security is expected to breakout from its horizontal base and starts to advance. It is essential that in order for stage 2 to be confirmed, volume must be higher ahead of the breakout. Stage 2 also see’s price trending above the 30-week moving average. It is recommended to buy the pullbacks to the 30-week moving average once stage 2 is established.

Stage 3 – The consolidation

In stage three, prices once again starts to move sideways after forming a high. The 30-week moving average also starts to shift sideways. Stage 3 shows a consolidation and could signal a continuation of the trend or a breakdown in prices. Volume is again seen to remain flat in Stage 3 but builds up ahead of a break out.

Stage 4 – The decline

If prices breakout lower from stage 3, then it is recommended to exit the long position. Of course, the breakout and the advance to stage 4 is validated by increased volume on the breakout and prices trending below its 30 week moving average.

Stage Analysis – Basic 4 stages
Stage Analysis – Basic 4 stages

Stage Analysis – Key components

The weekly charts form the basis and the starting point in stage analysis, according to the original guidelines. Because the stage analysis method is used for the longer term buy and hold method, the weekly chart is used, along with a 30 period (or 30-week) moving average. Price action is compared to the 30-week moving average in order to determine the specific stage.

Volume is an integral part to this strategy (and because it was written for the stock markets). Weinstein’s method outline that for a transition to take place, between stage 1 and 2, an advance on volume is required on the break out. A breakout that is followed up with low volume, according to Weinstein could result in a fake out with prices moving back to stage 1.

Stage Analysis – Example

The chart below illustrates an example of the stage analysis, using the 30 week exponential moving average.

After Alcoa slips to lows of $7.80, it forms a basing pattern with volume turning flat. The basing pattern or stage 1 is marked by a high and low with sideways price action.

Then, stage 2 is formed with a breakout above $10.00 on higher volume and price trending above the 30 period EMA. Buying pullbacks here offer a safe long entry which is taken until price hits a high and starts to move sideways entering stage 3 of consolidation.

Volume is again seen to remain flat and builds up following a breakout to the downside on higher volume. When this breakout occurs, traders can exit their long positions at 14.00.

Stage Analysis – Example (Alcoa, NYSE: AA)
Stage Analysis – Example (Alcoa, NYSE: AA)

Stage Analysis – Can it be applied to the forex markets?

The stage analysis in all its simplicity is nothing but accumulation/mark up/distribution process that is prevalent across all markets. Therefore, the above methods can be used to the forex markets as well. While Weinstein mentions using this strategy on a weekly chart, it can be applied to any time frame.

Stage Analysis – XAUUSD, H1 Chart with 34 EMA
Stage Analysis – XAUUSD, H1 Chart with 34 EMA

The above chart shows a 1hour time frame for Gold (XAUUSD) with a 34 period EMA. The stage analysis is quite clear here, although it is now in opposite as the markets are moving lower.

By combining the elements of ranging price action and waiting for a breakout and selling the pullbacks in the downtrend (or buying the pullbacks in the uptrend), the stage analysis offers a rather simple trading system that can be traded.

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