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Reviewing Basic Market Structure and Reversals

Dec 5, 2011: 3:02 PM CST

When you’re studying a price chart to assess trading opportunities, what is your eye drawn to first?

Is it the indicators? Is it moving averages? How about candles?

And when you are looking to put on a trade, are you taking a moment to address the context in which you’re placing the trade?

Is it a counter-trend fade? A pro-trend retracement? A breakout from a consolidation pattern (like a rectangle or triangle?) And when playing the breakout, are you looking to play a trend reversal breakout or a trend continuity breakout play?

Mike Bellafiore of SMB Capital recently shared a candid post from a trader about the importance of understanding Market Structure that inspired me to share a few tips on how to discern the current situation.

Let’s take a quick moment to review the foundational principle regarding trend structure that guides your answers to all these questions.

Here is the current “Structure” Chart of the Dow Jones over the last year:

Click for full-size (large) image.

Let’s step back to the most basic aspect of a price chart – price itself.

Stretching back to Dow Theory, an Up-Trend is defined as a series of higher swing highs and swing lows, while a Down-Trend is similarly defined as a series of lower swing highs and lower swing lows.

By extension, in an Up-Trend, the “Up” swings tend to last longer in both duration (time) and price (percentage moves) when compared to down/retracement swings in an Up-Trend, and vice-versa for a Down-Trend.

Translating that to trading opportunities, the BEST opportunities tend to occur IN the direction of the prevailing trend (relative to your timeframe).

However, not all trends last forever, and all trends will eventually reverse.

By definition, a TREND REVERSAL occurs when the following conditions are met:

When reversing an Up-Trend, price must make a Lower Low, Lower High, THEN swing back down to TAKE OUT (trade under) the recent Lower Low.

When reversing a Down-Trend, price must make a Higher High, Higher Low, THEN swing back to TAKE OUT (trade above) the recent Higher High.

In other words, a Structural Trend Reversal is a Three-Step price process – from this, we define not only Market Structure, but by proxy trading opportunities.

In the chart above, the first Trend Reversal Down occurred on August 2rd, 2011 when price broke and closed under the late June swing lows, the first lower low.

Notice that price formed a Lower High in July THEN swung back to take out the prior swing low to create the official Daily Chart Trend Reversal signal.

After a continuation down-move into October, price again reversed to the upside in mid-October after breaking above two mini-swing highs from July, forming a tight swing low on October 18th, and then breaking the final mini-swing high at the 11,700 level.

Price is currently labeled as a structural Up-Trend with a key “Make or Break” resistance challenge at the 12,200 recent swing-high level where we are now.

These are larger-scale, Structural Reversals on the Daily Chart.

A major key to understanding Market Structure – a big secret to trading – is the realization that Higher Timeframe Structure is BUILT by Lower Timeframe Structure.

In other words, the recent up-swing from 11,250 was built by – or comprised – its own Trend Reversal Signal and series of progressive swing highs and lows.

Let’s see that on the 15-min Intraday Chart:

The 15-min chart above shows us the November to present period which consists of a Structural (intraday) Down-Trend which reversed (ahead of the big end-of-November move, by the way) to an Up-Trend as labeled.

When viewing this chart, put it in context of the Daily Chart above – what we’re seeing is a simple down-swing which reversed into an up-swing in the context of a brand-new Up-Trend Reversal.

Even after the Trend Reversal AND the end-of-November rally, price has continued its intraday bullish structure with an additional progression of shorter-term swing highs and lows so far in December.

Continue to watch the current structure – particularly as it interacts with the key prior resistance swing high at 12,200 – for any breakdown in the swing high/low structure above (namely, a move under the 12,000 area that results in a future lower swing high).

You can also see the educational example of how the intraday structure reversed from Up to Down on November 17th (notice the sequence of Lower High, Lower Low, Lower High, then a breakdown of the 11,950 Lower Low).

Price declined – in basic structure – towards the 11,250 low after triggering an official intraday reversal under 12,000.

Identifying or Quantifying Market Structure is just the beginning – from there, you’ll look for confirmations/non-confirmations (including divergences) and other signals from your favorite indicators or methods to help you find low-risk, high-probability trades in the context of developing – or reversing – price structure.

However, if you’re not at least thinking about market structure, you could easily place yourself on the wrong side of a trending move and pay an unnecessary price for it.

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!

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The Current SP500 SPY Symmetrical Triangle Pattern

Nov 13, 2011: 12:58 PM CST

It makes sense that the broader market would pause to catch its breath after such a stellar October performance.

That’s what’s happening at the moment as the S&P 500 consolidates/pauses in a sideways/symmetrical triangle price pattern.

Let’s review the pattern and the current trendline reference areas and develop a game-plan of what to do with a future breakout.

First, the pure S&P 500 Triangle Pattern:

We’ll add more indicators to the mix later, though it’s often helpful to start any form of chart-analysis with a “pure price” chart free from clutter.

In this case, we see the 30-min intraday S&P 500 chart with short-term compressing (converging) trendlines that form a Symmetrical Triangle Price Pattern.

The current Red Upper Resistance Line comes in around 1,265/1,270 while the rising Green Support Line trades around 1,230/1,235.

That makes the “Midpoint” level 1,250 (the Center of the developing pattern).

The simple play would be to trade short-term within the boundaries of this pattern intraday and then prepare to trade the initial breakout – a down-break quickly targets 1,215/1,220 while an up-break targets 1,290.

Triangle Patterns tend to produce breakout/impulse moves that travel beyond the initial targets of the prior imediate swing highs and lows, and for that, we’ll need to turn to the higher frames.

But first, let’s take a look at the SPY ETF and throw volume insights into the mix:

I added a yellow horizontal “Fair Value” or “Midpoint Value Area” mark at $125.50 which is roughly the 1,250 area in the S&P 500. Otherwise, the breakout area is $127 and $123/$123.50 respectively.

Volume has a tendency to decline in the context of a consolidation pattern and that’s what we’re seeing at the moment.

Specifically, we’re seeing a form of distribution volume wherein volume steadily declines as price rises higher and then increases as price declines.

Distributive Volume suggests a downside resolution, but we merely need to look back to October’s non-stop rally to see how price defied the odds and continued its upward march to where we are now.

With the levels and volume insights above us, let’s now jump to the Daily Chart for more chart-facts:

The Daily Chart not only puts the current Symmetrical Triangle in context, but it also gives us extra reference levels that help us understand WHY price is consolidating at the moment.

Above price is the confluence resistance from 1,275 (200d SMA) and 1,295 (a price polarity level and October swing high).

To over-simplify, you can refer to 1,300 as the key major resistance level that – if broken – should lead to a “Popped Stops” breakaway move higher towards 1,350/1,375.

On the downside, we have rising support from a longer green support trendline as drawn as well as the rising 20 and 50 day EMAs (1,240 and 1,220 respectively).

Just as you can oversimplify 1,300 on the upside, we can oversimplify 1,220 or even 1,200 as the critical downside support confluence which – if broken – should produce an impulse breakdown back towards 1,120/1,100.

We can also see that Volume is suggestive of a downside break, but we make money trading PRICE (what actually happens) as opposed to indicators (which clue us in to what is SUPPOSED to happen).

Keep these dominant short-term reference levels in view as we trade the week(s) ahead.

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!

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Reference Charts on Dual Intraday Divergence Reversals

Oct 23, 2011: 5:27 PM CST

Mid-October gave us back-to-back examples of one of my favorite patterns and trade set-ups – that of the intraday trend reversal on clear positive dual divergences.

We’ll be using the @ES Futures as our proxy, but this example extends to any index futures contract or related ETF (including the leveraged funds).

Let’s take a moment to learn about this concept and see clear reference examples from October 20 and 21.

Here’s what we’ll emphasize in this post:

Positive Divergence in Momentum (using the 3/10 Oscillator)
Positive Divergence in NYSE TICK (Market Internal)
Confirming Reversal Candles
Price Confirmation via Trendline and EMA Breakthroughs
“Stepping Inside” the structure using the 1-min chart

Trends (on any timeframe) often end with divergences, and in this case we’ll be discussing a very short-term intraday trend using the 5-min chart.

Using the 3/10 Oscillator (middle panel) and the NYSE TICK (bottom panel), we see a higher indicator low going into 11:30am while price pushed to new intraday lows on October 20th.

We call this a “Dual Positive Divergence” because both TICK and Momentum diverge with the new price low.

From a candle standpoint, we see a Bullish Engulfing Pattern, or as much as a 5-min bar can ‘engulf’ another one with the power-bar off 1,194.

You can see the resolution of a successful reversal into the session close, giving rise to a breakout trade (above 1,200) and a “Bull Flag” retracement trade at 1:30, but that’s for another post.

Let’s step inside the positive dual divergence action at 11:30am to see exactly what the 1-min chart showed in real time:

I froze the chart just after the confirmation breakthrough – a BUY signal – so you can visualize what this looked like in Real Time – which is your goal in understanding and trading this concept.

We use the lower timeframes to clarify or “step inside” any situation or pattern we’re seeing on the higher frame, and in this case the combination is the 5-min and 1-min frames.

Look closely to see the “inner-workings” of the clean positive dual divergence into the 1,193 low just before 11:30am.

It’s generally not advised to fight a trend on the SOLE basis of a positive divergence, but some aggressive traders do it.

Personally, I prefer to wait for price confirmation via a clean breakthrough of a falling clear trendline (as seen above) or through lower timeframe EMAs (we’re seeing the 20 and 50 EMA in all charts) before jumping in with a reversal trade.

The main idea of the lower frame chart is to see finer/clearer details that may not show up on higher timeframe charts… and also find the clearest buy signal via price confirmation.

Once you understand or see that price is likely forming an intraday reversal, you can trade accordingly – playing future breakouts or retracement trades in the context of the new intraday reversal.

At a minimum, DO NOT short-sell after clean positive divergences and breakthrough confirmation signals like the ones you see above.

That’s the main lesson from this example, and to make it even clearer, let’s see the same 5-min and 1-min timeframe charts of the very next day – October 21:

Using the description above, we can see a similar 5-min positive dual divergence in Momentum and TICK, this time going into 1:00pm CST into the 1,220 level.

We see a similar – yet far more powerful – Bullish Engulfing Reversal Candle, but this time we have a series of bullish lower shadow candles ahead of the Engulfing Candle.

You can see the successful reversal that developed off this positive divergence situation.

Let’s step inside the 1-min chart and freeze the session as it looked “in real time” as these divergences developed:

The 1-min chart gives us a clearer picture with more detail than the 5-min chart in terms of spotting dual divergences in real time as they develop.

We also see the confirmation signal from price via the breakthrough of the 20/50 EMAs and the intraday trendline – the preferred buy-in spot for a reversal play.

This is the kind of in-depth trade analysis and lessons we discuss in each evening’s “Idealized Trades” report for members.

It’s also the type of examples I’ll be explaining in much more detail at the upcoming Las Vegas Traders Expo in November, if you’re able to join us all.

Take a moment to study these charts for additional insights and apply the lessons to your own trading strategies.

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!

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IBM Quick Lessons in Multiple Timeframes, Divergences, and Earnings

Oct 18, 2011: 9:34 AM CST

Wow – if you missed the post-market action in IBM’s earnings announcement, you missed a huge move that took so many traders by surprise.

While this post will focus mainly on key lessons from the charts, it’s worth noting that trading around earnings increases risk, especially if a stock’s earnings differ greatly from what’s expected… or even in IBM’s case, when earnings are different by mere pennies from expectations ($3.19 reported versus $3.22 expected).

Let’s focus our attention on two main lessons – that of higher timeframe analysis and the massive multi-swing negative divergence that undercut the recent rally.

Let’s start with the “Over-extended” Weekly Chart:

Let me just focus on two things on the chart above:

A Rising Primary/Long-Term Trend
The Two Recent Closes (spikes) through the Upper Bollinger Band

When doing analysis or finding candidates to swing trade, it’s often best to start with the higher timeframe charts and work down from there.

Let’s focus on the two spikes above the upper weekly Bollinger Band – this simply indicates the stock is “over-extended” and generally more likely to fall in the immediate (next) move than rise.

As we look at the lower timeframe charts, keep in mind that price was “over-extended” above its upper Bollinger Band into $190.

This simply suggested it was NOT the time to get long IBM shares – and for very aggressive traders, it might be an opportunity to short-sale (or buy put options) if the lower timeframe charts showed bearish patterns/signals.

With that, let’s drop to the popular Daily Chart:

The Daily Chart steps us inside both instances where price over-extended above the weekly Bollinger Band.

The main thing to note on the Daily Chart is the power-rally into $190 which was undercut by a persistent negative volume divergence. On each day of higher prices in October, volume was a little bit lower – volume divergences tend to precede reversals.

Ok – so we have the weekly chart showing a poke outside the upper Bollinger and the Daily Chart also showing an over-extended rally that is being undercut (non-confirmed) by declining volume.

Again, this is NOT a situation that would compel a long (buy) trade, but instead would have aggressive traders taking the timeframes even lower to see if a potential short-sale opportunity triggered.

Let’s see two intraday timeframe charts, starting with the 30-min structure:

I mentioned the negative volume divergence on the Daily Chart, but the 30-min chart makes the divergence abundantly clear – that’s one of the benefits of multi-timeframe analysis (the lower timeframes clarify the picture – or reveal more information than the higher frames).

I’m now adding the 3/10 Momentum Oscillator to the chart to get a sense of what Momentum reveals about the price swing in motion – momentum declines steadily (along with volume) as price continues its rally higher.

The 30-min chart reveals clearer negative Volume and Momentum divergences into an over-extended situation on the higher timeframes – once again, NOT a compelling spot to plan a buy trade.

Let’s see if the 15-min chart shows us a potential short-sale opportunity:

The 15-min chart is basically the same as the 30-min intraday chart with one big exception:

Price broke and closed under the 20/50 EMA structure early on October 17th, and then these EMAs crossed “Bearishly” later in the session.

Price then rallied INTO the EMA Crossover (what I call the “Cradle Trade”) into $188 just ahead of the close… ahead of the earnings report.

This sets up a “Make or Break” situation where price either continues its breakdown lower – in conjunction with a typical sell-swing as suggested by the higher timeframes – or otherwise does the ‘unexpected’ or lower-probability outcome with a firm breakthrough higher above $190 which would target $200.

The outcome this time was the expected or probable thesis:

Price had greater odds of falling/declining due to the higher timeframe “over-extended” rallies above the upper Bollinger Bands which was under-cut by negative volume and momentum divergences on the intraday/lower frames.

From that thesis, price gave a set-up or short-sale trigger on October 17th via breakdowns of rising trendlines and rising EMAs – along with an EMA cross-over (all of which were potential trade entry triggers).

The stop would go above $188 (tight) or preferably $190 depending on your risk tolerance.

To summarize, the main/quick lessons to learn from this situation are the following:

Weekly Spike through the Upper Bollinger (over-extended)
Daily Power-Rally on Declining Volume Each Day
Intraday Multi-Swing Negative Momentum and Volume Divergences (clarified)
15-min EMA Cross-overs and Trade Triggers

Take time to learn the lessons from situations like these, as these lessons will repeat into the future on other stocks and markets… just the end-result won’t likely be such a sudden over-night resolution thanks to an earnings announcement to get the downward ball rolling.

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!

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Charting Crude Oil into Daily Resistance Oct 13

Oct 13, 2011: 9:01 AM CST

What’s going on with Crude Oil at the moment?

Let’s take a look at the Daily Resistance Level along with a “step-inside” perspective from the intraday chart.

Let’s start with the prevailing Daily Chart trend – it’s a downtrend as evidenced by the progressive series of lower price lows and lower price highs, which is confirmed by the EMA Orientation (the 20 EMA consistently resides under the 50 EMA).

A down-trend is in force until clear signals prove a reversals – none of those exist at the moment.

That takes us to our present price swing into the falling 50 day EMA, which has turned back price three prior times since price reversed lower in May 2011. Logic would suggest that the 50 EMA would again turn-back price a fourth time.

Also, I drew in little “bear flag” patterns which also have repeated three times in the past… although the current rally does NOT take the form of a bear flag – it’s still a move into the EMA resistance near $86.

It’s also worth noting that a Positive Momentum Divergence has formed into the late September low under $77.50… but you can also see how a similar positive divergence formed at the end of June, and the outcome through July.

So, the main idea is that the $86 level is a key resistance area that is a “Make or Break” between buyers and sellers.

Let’s now step inside the 15-min intraday chart to see if we can get a clearer picture:

Looking at the @CL Futures, we see the ‘inner-workings’ of the recent rally into the $86 daily chart target level.

As price entered (tested) the $86 price target, a clear Negative Momentum Divergence undercut the rally into $86 – that’s not something you want to see if you expect price to continue its rally.

In addition, this morning’s breakdown of the 15-min EMA and trendline structure – roughly at $85 – is a sell signal, and as of this writing, price appears to be confirming this sell/hedge/protect signal.

For an educational reference, you can see what happened in early October with regard to the $77 Daily Chart support level that was met with an intraday Positive Momentum Divergence as labeled.

The recent up-swing also began with an opening impulse gap.

Anyway, this is a good example of how it is beneficial to combine two timeframes to get a better picture of the likely/probable – though never guaranteed – next immediate swing in price.

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!

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