A Great Reference Lesson on Divergences and Intraday Reversals from June 3

Jun 4, 2013: 12:09 PM CST

The stellar intraday reversal in the US Equity Indexes mid-day June 3rd gives us a great educational reference lesson in visual chart patterns that tend to precede divergences and how we can adapt in real time.

Let’s take a look at the downtrending intraday action, multi-swing (and multi-indicator divergences), and the trendline breakout that triggered a valid intraday reversal signal.

We’ll start with the SP500 index as it looked at the intraday bottom on June 3:

What we’re seeing in the 5-min chart above is the SP500 over a three-day time period from Thursday May 30 to mid-day June 3rd (in hindsight, this is the absolute intraday low but this fact is not known at this time).

A persistent intraday downtrend continues if we look at price in isolation, but if we add various indicators including Market Internals, we’re likely to see non-confirmations or ‘caution signs’ with respect to the odds of the downtrend continuing.

I’m showing the 3/10 Oscillator (a custom momentum indicator), NYSE TICK (stocks ‘ticking’ higher at a given moment minus those ‘ticking’ lower) and the NYSE Breadth (advancing issues minus declining issues on the session, again at a given moment in time).

Generally, you want to see a downtrend in price be accompanied with new indicator lows in Market Internals and Momentum Oscillators as was the case into the close of May 30th and throughout the entire session Friday May 31 (note the new price lows with expanding new lows in the indicators).

It’s generally safe to play retracement trades when this situation develops.

However, no trends last forever – especially intraday trends – and we see early signs of Non-Confirmation or positive divergences on the opening of Monday June 3rd.

While price does continue trading lower, all three of our indicators register higher lows – the momentum oscillator and NYSE TICK indicator actually registers a series of three higher lows as price pushes to lower intraday lows.

Here’s a clearer image of this situation as seen on the 1-min chart:

Lower frame charts provide more information than higher frame charts – in this case we see the interaction of the 5-min and 1-min intraday charts.

Note the lengthier visual positive momentum oscillator divergences and the clearer perspective of the NYSE TICK and Breadth Divergences relative to Friday’s readings.

Note also the steady increase in NYSE TICK from 9:30am CST to 10:30 – even though price continued to trade lower, NYSE TICK consistently registered higher lows along the way.

Though Breadth did trend lower, note that the value remained higher than Friday’s closing low along with the majority of the readings on Friday’s session (when price was higher).

It is important to note also that divergences can persist and extend as a trending environment continues (resulting in losses for those ‘fighting’ or fading the trend with aggressive reversal strategies).

Divergences are warning signs of possible future trend reversals – to initiate safe trades, we often need to wait for actual confirmation from price in the form of a breakthrough above (or beneath) an established trendline.

The exception to this rule is when price successfully trades to a known higher timeframe support or resistance level such as a trendline, daily moving average, or Fibonacci Retracement.

Here’s the situation as it developed and resolved throughout the remainder of the session and into the next day:

(click for full-size image)

I drew “Arc” or curved trendlines as a better measure of price movement.

Note the breakthrough and quick upward impulse into 11:00am CST which triggered an aggressive reversal signal near 1,627.  This put the intraday structure into the “Bullish Bias” which I highlighted in green.

The situation continued with a rally throughout the remainder of the trading day and into the next session into 1,645 where another form of negative divergence developed into the 1,647 intraday high on June 4th.

Price broke under another rising or ‘arc’ trendline which forecast another short-term/intraday reversal and “Bearish Bias” which I highlighted in red.

During directional bias phases, look to trade retracements or breakouts and avoid counter-trend or retracement trades.  Always be on guard for new divergences or new triggers from price breakdowns of trendlines or key index (price) levels.

The goal here is to put yourself in the mindset of real-time price activity as it occurred as much as possible in order to internalize the lesson from the example.  Focus on the factors that preceded the reversal so you’ll be able to spot similar situations in the future.

At a minimum, we want to study trend reversals so that we do not continue using pro-trend strategies when chart-based evidence favors a reversal.  Of course, our ultimate goal is to profit from reversals as they occur, and that develops over time with practice and experience.

These are the types of lessons I highlight for members each night in the Idealized Trades Daily Reports (along with planning strategies or the next day).

Join fellow members to receive daily commentary and detailed analysis each evening by joining our membership services for daily or weekly commentary, education (free education section), and timely analysis.

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

Corey’s new book The Complete Trading Course (Wiley Finance) is now available along with the newly released Profiting from the Life Cycle of a Stock Trend presentation (also from Wiley).

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