Chiu:

Yes, when I have a strong bias on the market, I play it out through a chosen ETF or futures contract. In this case, I chose to use the DIA (Diamonds ETF for the Dow Jones). I chart and annotate each Dow component each evening and make notes and aggregate them into an opinion of possible upcoming broader action. I also scalp using the QQQQs and SPYs. For futures, I only trade the YM (Dow-Mini). I understand the price levels and contract size intuitively.

My apologies on the mispricing error. I intended to type the $120 price but mistyped the lead price as $112.

My trade entries were not based on divergences, no. They were strictly trend trades (retracement trades, at that) because of the daily chart bias for a new swing low and I played out this bias through the (much) lower timeframes. Although I am highlighting momentum divergences on the main blog, and chose to post this chart to annotate momentum divergences, they are only one of a handful of patterns and strategies I use in actual trading. I am building a knowledge base on my site so that when I reference "momentum divergences" people will have a post or article to come back to and I won't have to explain the same concept in each future post. I want to help people find their own strategies, and what has helped me develop my own is learning from other traders, finding what works and then adapting it into my own style that makes sense for me and my risk tolerence.

I am setting up a resource of my experience and strategies for reference and education for myself and others. Any specific chart annotations I post will be for educational purposes unless readers strongly request that I post analysis and charts. My goal is to keep this site educational in nature with actionable strategies and concepts, and not post individual trades unless they teach a lesson. The lesson from Wednesday's trades (to me) was that bias can cloud reality and result in missed profits. The overarching goal is that fear and doubt are decreased by increasing your knowledge and confidence.

Corey, thank you for your response. For the two trade examples given, are they DIA ? On 14 Mar 2007, they have not reached 112.x level ?

In both cases, is there a divergence for the trade entry ?

Chiu:

Although I am posting only the one-day five minute chart, I am comparing swing charts and candle charts from previous days' data which provides a clearer picture. My active trading screens show the 5 minute, 15 minute, 30 minute, and daily charts. I also display the TICK, TIKI, TRIN, and Breadth for confirmation/non-confirmation. I was so biased short because of the daily chart impulse formations I posted about previously and I was anticipating a new swing low which occurred, but was terminated by the surge in buying volume in the chart above.

Higher time frame signals are more valid than short-time frame signals, and stay valid until invalidated on the same time frame. Smaller time-frames exist to fine-tune entry and manage risk much more effectively (as opposed to seeing a pattern on a daily or weekly chart and blindly entering).

I had a smaller short swing position I held overnight which was entered the day before this chart based on overall weakness and a strong intraday down trend. On the 14th, I used leverage in two trades only when price pulled back to the declining 20 period moving average and took off those 'scalp' trades when price made a new swing low then re-entered when it retraced back.

Scalp Trade 1: Entry $120.72 short Target: S1 Pivot (achieved) and exited at $120.18
Scalp Trade 2: Entry $120.19 short (after rally BACK to S1 pivot) Target: Beyond swing low and exited at $120.82 (on the white bar side, not red side - the down move was so swift that I had a bad fill up).

I took my final aggressive short (didn't know it would be the final one) when price failed at the S1 pivot level. The divergence scared me and I exited (quite happily) when I saw volume pick up and I suspected a possible climax (watch yourself when you get too excited in a position, as I was). Friends and I were discussing this and some went long while I backed off and disengaged, as I typically don't trade much during lunch and afterwards unless there is a compelling reason to do so based on my observations. I've found my style of "non-hyper" day-trading works best for me from 9:00am - 11:00am (Central) and 1:00pm to 3:00pm. I exited my swing short position when price rallied so hard following this climax and went flat as the market continued higher. I was happy and did not want to take on any more risk at this point - I suppose I should have.

Because my bias was for lower prices, I sought confirmation and set-ups that supported this bias. It helped for a bit, but this is also a good lesson that, while bias can be helpful, it can blind you to new opportunities if you are too certain of your prediction. I need to ease up and be more open in actual trading.

You mention that you use 5 minute chart and trade more in the morning. As there are only 12 candlesticks in the first hour for 5 minute chart. You would like to see the divergence, could you share what time do the signals usually come ?

Are you able to share some charts on your entrance and exit points for some of the trades ?

Jordan (and everyone)

This chart I drew should illustrate my text above. What I am most interested in trading when I see this pattern (and there are other patterns I trade) are the two Red Zones, or the "Highest Probability Points" as understood by me. It's not that this is a rare pattern, but it obviously does not occur daily, but it helps to recognize it and know what the most likely play is when the pattern sets up.

<img alt="NMH Play" src="http://blog.afraidtotrade.com/wp-content/uploads/2007/03/nmh-plays.JPG">

What happens next? It doesn't matter to me. My system can't capture that. If it keeps trending, great. If not, I just captured profits from the market and I go away happy. If I was wrong, then my stop is so close to my entry, that it doesn't really matter. What makes this pattern work is that odds are greater than 50% for a successful retest on the first two swings higher and the target is usually at least two or sometimes three times greater than your stop (provided it is not too close to the moving average below).

The Blue Circle is the "Sweet Spot," which also serves at the true point at which the downtrend is now classified as an uptrend. Price makes a higher high, swings down to make a lower low, and then swings back up to TAKE OUT the most recently formed swing high. Do you enter a position here? You can, IF you play for a large target and realize that a counterswing is almost certain. Why not wait to establish the position AFTER this counterswing?

For me, there are two plays:

1. Following the new momentum high
2. Following the trend confirmation zone

After that, it's up in the air. No matter what, I STILL play for a small target and rarely play for much more than a bit above the most recent swing high.

Jordan, this is my passion! I love the questions. Thank you for the questions - it makes me feel like my examples are worth it if I know I am helping others.

The ideal pattern for trend birth would be a gradual slowing of momentum and swings, which lead to an observable divergence, regardless of your chosen indicator. An area of consolidation should form as price winds down to an equlibrium point between buyers and sellers (both are satisfied), and then some force later comes and knocks the balance out of equlibrium in the form of an impulse of new information and new (we'll say) buying pressure on the system. You don't want to buy *during* the impulse, because impulses can't be predicted with accuracy and almost always resolve in a corrective counterwave.

You would be interested in establishing a position and playing for a larger target on the pullback, ideally to a zone where moving averages act as support now. Many times, these areas result in (at least) three pushes (or swings) higher and might lead to more. The ideal situation would find price and momentum making new highs together, adding confirmation to the new trend. If this is the case, stick with your position and ride out the three pushes (or three waves). Remember, momentum (imbalance in supply and demand) precedes price and when momentum makes a new high, you can expect new price highs are right around the corner.

However, it is natural to see swings contract as the trend is mature and more people jump on board. It is fine to see a momentum divergence early, as it initially acts as a warning signal. These patterns are more pronounced on the intraday charts than the daily or weekly charts. But you're right - a momentum divergence early in a trend can be a normal occurrence. Buying pressure rarely remains equally strong on subsequent swings.

For me and my strategy, I may keep a small position on for a longer duration after spotting the ideal pattern described above (and described as the "Sweet Spot") but I will play with leverage, or play at all, only on retests. In other words, when I see a new momentum high and new price high, I am playing for a retest of that new price high only. Following the next corrective wave, I may look to establish a new scalping (or retest) position into the next swing higher - but I am only playing for a retest. When momentum begins to decline, it decreases my confidence, and if I feel like I must trade, I will trade with greatly reduced size as the trend matures - typically, I only look to play the first two swings of a newly perceived move intraday.

Momentum divergences do not signal trend change immediately. Principle one puts the odds in your favor of a trend continuing rather than reversing and so this is my number one principle that guides me. Momentum plays are simply derived from this "trend continuation" rule. Odds favor playing for small targets in the direction of an established & confirmed trend until you experience a "blow-off top" or "capitulatory bottom". Some people like to hold for the duration of a trend, but not me. I do not like long-term market exposure -- too much can go wrong. I like seeking the market's or a stock's sweet spot and then extracting that play from the market. I like buying at the moving average pullback where I expect price to reverse and I can put in a tighter stop and I'm not chasing the stock. I'm fine missing other portions of a move. I also hate holding trades through retracements.

This is a good conversation! I enjoy it. I'll be able to explain more through questions in the comments, rather than posts in the main section, and I strongly encourage questions.

Corey

Corey,
Thanks so much for taking time to explain in detail to me. As one commentator puts it, you've “the heart of a teacher” :)

From what I understand in your reponse (please correct me if I'm wrong, still a newbie), you are saying that following NMH and new price high, it is natural to expect momentum to decrease on each new swing higher and no cause for concern in exiting position earlier? And because there is a NMH and new price high, this is actually the start of the trend and momentum divergence is not so applicable?

Chiu:

Absolutely. The default settings for the MACD are 12, 26, 9 (12 "fast" EMA subtracted from a 26 "slow" EMA and then smoothed by a 9 period average for the signal line).

The settings I use would be programmed 3, 10, 16 (a 10 period EMA subtracted from a 3 period EMA and then smoothed with a 16 period look-back, which is longer than the default settings). Although I haven’t mentioned it yet, the longer “signal” line serves as a trend condition identifier and lets you know the intermediate trend.

I use this oscillator for momentum readings - impulses and divergences. There are other applications for this indicator but I am most comfortable with these two and have found success through them.

This concept is credited to Linda Raschke of LBR Group and is known as the “3/10 Oscillator”.

Could I what is the parameter setting for MACD oscillator, you mention 3/10. Usually MACD has three parameters, macd/fast/slow, could you share ?

Thank you so much Oda for your kind words. I can say the same things about you. I thoroughly enjoy your approach and passion to explain charts and market situations at your site.

I'm having a battle keeping my posts and responses shorter! I'll typically write something and then edit out much of it because I am trying to keep explanations simple to understand. My passion is in the market and understanding principles and high probability events and I tend to talk too much about it! I've kept friends up all night at times sharing new ideas and insights - if they ask.

I'm so humbled by the attention so far. What I was doing was setting up the site and posting strategies, partly for me to have as a reference, and for others to reference as necessary. My premise is to overcome fear through education and expanded knowledge, and that is what I am building here. I am so thankful to the readers and those who link and deeply appreciate everyone's support and emails. It has humbled me and challenged me to be as professional and timely as possible and I take this very seriously. It has provided a huge level of accountability and I promise to honor that trust.

Corey

Corey,

Great article/insights to your individual style as well as a really great response to Jordan! Thank you for taking the time to answer his questions and "then" some. You have what I call "the heart of a teacher" and it shows in all you post. This sets you apart from most of the Bloggers out here because you obviously care enought to post detailed answers. I also have noticed you are being listed on numerous blogs this week and even spotlights on the Trading Goddess' site yesterday. People are taking notice of you and what and how you are doing it. Please keep it up and remain pure to your personal style and motivations - this is what will keep you separate form the "masses"!

Regards,

Oda

Jordan:

Thank you so much for your comment. Remember, each person's trading style will be different, and I am constantly learning, and am happy to share my insights with others and hope to learn from them as well.

I set up biases reading the daily charts and then attempt to play out my scenarios on the intraday charts. I will swing trade when stocks, or ETFs reach critical technical decision nodes, but I find holding trades a long time difficult (it's just my style and natural risk aversion). I occasionally play option spreads if a trend is particularly strong. I am naturally inclined to day-trading and scalping because I like to go into the market large and exit quickly and be flat at the end of the day so that my analysis is clear for the next day. I trade the hardest in the morning and then will take off during the lunch doldrums usually.

For my chart analysis, charts are my way of gathering data and looking for high probability movement (which usually occurs in small bursts as I play for small targets). I find the 3/10 MACD Oscillator most helpful for momentum readings, moving averages (20 period EMA and 50 period EMA) most helpful when I identify trending conditions, and I tend to avoid rangebound markets completely (it is my natural bias to be out of the market unless perceived opportunity - which come from my experience - arises). I've found the more data I gather, the LESS likely I am to make a trade. I'm constantly fighting a battle to keep my information focused and decisions fewer.

For Swing Trades, I will also study the same patterns, but on daily (or even weekly - but rarely) charts. The market principles and concepts are the same (or very similar) concerning time frames. A new momentum high on a weekly chart sets up the same pattern and probability on a 5 minute chart, yet the plays and parameters are dramatically different. I like shorter time frames because it gives near instant gratification and I don't like the uncertainty of holding a trade for weeks or months. Fundamental factors (like the Yen Carry Trade situation or economic reports or interest rate adjustments) can affect the trade in unanticipated ways - I try to be a technical purist.

You are absolutely right in regards to the above New Momentum High and "Impulse Buy" set-up I described (and, coincidentially, did not take today because I was so baised to the short-side). Following a NMH, if it is particularly strong enough (as this one was in hindsight), you can expect a "three push" move into the new trend direction (similar to Elliot Wave Theory, yet I do not subscribe to it). Momentum is expected to decrease on each new swing higher. If it doesn't, then get in the trade aggressively.

Yes, I observed momentum sell divergences here and would have clearly exited any long position based on my personal readings and tactics. I almost pointed these out above but did not want to overload the chart with analysis. Today's action highlights rules 1, 2, and 3 of the Basic Market Principles and I had to post that. The momentum divergences also kept me out of afternoon long positions once I realized we were going higher for sure (waiting for confirmation kept me out - bad move). I missed the "pure" swing in my perception.

My reading now? This is a clear momentum divergence and caution is warranted to further upside potential. Does it work 100%? No. Nothing does. But do you want to be committing new capital long here? Absolutely not. The odds would be squarely against you (on the five minute chart, that is).

I also did not post the 15 minute chart, but I was screaming to some trading buddies how much of a divergence was building as price etched new lows on the day yet the oscillator was almost steadily trending up (diverging). The capitulation volume also jumped out at me that the down move was probably over for the time being. I exited my short position just after the capitulation and divergence, but I was too cautious and skeptical to put on a long position and reverse my opinion. Some friends of mine did, however. They had guts.

I wanted to highlight also that the momentum buy divergence is just about as perfect as you get. There's a long push down and then momentum declines on the sell side. This is exactly the point to anticipate and play divergences. Not in trading ranges and not at the beginning of trends. Momentum divergences test out best only during mature trends.

Concerning signal exits, realize that - for me - once I observe a divergence, I will play for a small target only. Also, when I observe a new momentum high, I also play for a small target - the most recent swing high. Had my emotions been clear and bias neutral (instead of being so negative on the market action), my play would have been the following:

Observe New Momentum High and New Price High following momentum buy divergence
Wait for pullback to the 20 period EMA
Enter trade with leverage and place stop below 20 period MA (this was about $120.50. Probably would be filled in that area. Stop would be about $120.35 or lower).
Play for the most recently formed swing high at $121.00. I am risking about 15 cents to play for 50 cents.
Exit trade at swing high.

Alternatively, you could have played for slightly above the swing high, but the further price goes, the lower your probability of continued trend action.
I would anticipate a pullback and then possibly enter again with a smaller size - maybe even on leverage - if I played for the "Sweet Spot" trade play.
Exit again at the most recent swing high.

I am content to make two or three high probability trades per day. I'm not your typical hyper "daytrader" or "scalper". I avoid "news" stocks and impose pure technical analysis structure on the intraday frames.

I hope this helps a little bit. Please let me know if there are additional questions and I would be happy to clarify.

Note: I almost posted the SPY and QQQQ here, but the patterns and analysis are exactly the same for all the major market ETFs today.

Hi Corey,
Thanks for this awesome blog! Very informative! I would like to understand your trading style better. From what I've gathered from your past posts, you are mainly doing day-trading using 5, 15 min charts. Technical indicators you use for day trading are 3/10 MACD and 20 EMA? I noticed you have a blue line MA in this chart, is that the 20 EMA or another EMA? Do you also apply the same indicators for swing trades if you do have any?

Another point that I've been pondering about is regarding NMH and hope you can help me understand abit more. Using the above example where entry is made after NMH, I notice that the MACD is having lower peaks as price continues to climb up. Is this also considered a momentum divergence and signal exit once a lower MACD peak forms even though price target has not been achieved?

Thank you!