How to Trade One My Favorite Reversal Patterns
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.
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.
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.
#-ad_banner-#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.