Explanation in the Comment Thread
I wanted to draw attention to a conversation taking place between Jordan and I in the Comments section of the post “March 14th Analysis”
In it, Jordan asks me to clarify points concerning momentum divergences and the “Impulse Buy” pattern which illustrates the “Momentum precedes price” example.
I also wanted to note a new chart of McDonalds (60 minute) in line form and bar form which highlights the Impulse Buy pattern and Momentum divergence.
Although I trade other patterns, I find this set-up to be most profitable and most comfortable for me to execute consistently.
The simple explanation is that after a downtrend (reverse the terms for uptrend), momentum and selling decline and a base forms (you should expect a longer base to form than in this example). Equilibrium is achieved between buyers and sellers. Eventually, new information enters the arena and throws participants off balance, which creates (in this case) a strong upside momentum thrust. The problem is that you cannot anticipate this momentum thrust, and divergences are often good only for small targets (and represent countertrend plays).
I look to enter a position following this momentum thrust (and the retracement against it) when price nears a key moving average. I then play for the most recent swing high. I repeat the pattern once price corrects back to the moving average and play again for the newly formed swing high. Stops are placed a short distance below the moving average which allows me to enter with a tight stop (but not too tight).
Another point to note (which I have not illustrated on the chart) is that the new momentum low on the left side of the chart corrects up to the moving average (when the bars turn green) and you would be wise to play this new momentum low short for an equal swing or at least a retest of the most recent swing low. Entry would be around $44.25 and the exit target would be $43. Risk would be about 25 cents at $44.50 (slightly above the declining 20 period moving average).
I plan to explore this idea in a further post. For the meantime, feel free to jump in and participate with us in this discussion – or at least scan it briefly.
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