Friday, 1 April 2011

How to trade divergences

I often talk about momentum divergences and then waiting for price confirmation for entry. As ever, Corey Rosenbloom at Afraid to Trade summarises this very well in a recent post:

Please read

US Market Summary

Good Morning All,

US markets were relatively flat overnight and consolidated recent gains. It is non-farms tonight so it is really important to remain flexible and follow the price action. We are coming into some significant resistance areas after the Eminis nailed the 1300 support level cited here two days ago. I have a few interesting setups lining up which now need price action to confirm.

One of my concerns currently is the weakening breadth figures despite price making higher highs. This is a warning flag. Since the March lows, we have seen the following closing readings:

21/3/11: 2473 NYSE advancing issues
25/3/11: 2265 NYSE advancing issues
30/3/11: 2212 NYSE advancing issues
31/3/11: 1761 NYSE advancing issues

Thus despite the S&P trading from 1260 to 1330 during this time span, the number of closing advancing issues is declining and not following through. This is not a short signal, but certainly this is a warning flag.

S&P 500 June Eminis 60mins:
The June Eminis are trading into my 1328/1330 target. There is a potential 3 Indians ending pattern lining up here into this zone. This setup was made famous by Linda Bradford Raschke in her book Street Smarts. Bottom line, price has made 3 higher highs yet the momentum indicator has made 3 lower lows- a strong bearish divergence. The entry for this trade is a bearish 15min or 60min reversal candle out of the resistance zone.

Dow Jones Cash 60mins:
The Dow Industrial and Transports have rallied right into their previous highs. This setups up a potential double top trade. Price has come along way since I recommended the double bottom trades in the middle of March: and The key to understand as ever is Risk/Reward. As traders, we need to be selling/getting flat into these levels and then reassessing. If there is no reversal, than we move on and look for breakout trades in the coming days after consolidation.



Eurostoxx June 60mins:
The Eurostoxx is also showing a possible 3 Indians ending pattern. Last night we filled an open gap and closed right on a minor trendline. Any further weakness below 2835 should trigger a potential short entry with tight stops.

EUR broke out of the Flag pattern I have been monitoring which now targets 1.4250. I still think we are in a broader range from 1.40 to 1.4250/1.43 and thus we need to trade the range until a clear breakout ensues. The DXY double bottom trade is still in play but we need to see a strong close above 77 on the June futures for a strong entry signal in that contract.

EURUSD 60mins:

DXY Futures June Daily:

In conclusion, the trend remains up but we are coming into clear resistance levels with underlying breadth weakening on a non-farms night. As traders, I think stepping to the sidelines makes sense and look for bearish reversal candles to potentially short with tight stops. The bigger picture trend remains up and we will continue to look for buy setups should price come off or if consolidation patterns ensue.

SPI/ASX200 Morning thoughts

The SPI is indicated to open at 4867 this morning which is around yesterday's closing highs. I think today is likely to be a consolidation type day with the possibility of some weakness/"profit taking" should 4845 break to the downside. Note it is a non-farms Friday and thus activity may be subdued.

I must stress once again that the trend is up on all time frames and we must continue to buy breakouts above resistance. Thus if we break 4870/75 on good volume, look for a move up to 4900.

Scenarios I am following today:
i) Look to buy support at 4835. Use tight stops and if this level breaks, get short targeting 4800. This target may need a few days to play out
ii) If we continue to consolidate between 4840 to 4870, look to buy a breakout of this range later in the afternoon targeting 4900

I always keep the ASX200 cash chart on my screens. Key resistance levels today are 4847/4850 which is the 78.6 retrace level and a previous major high. 4864 was the high prior to the major sell off

Good luck. I will update throughout the day