In this week's showcase, we'll take a look at using momentum to trade a 15 minute chart of the S&P market. The recent upgrade to the Cycle Forecaster, which now allows forecasting of indicators as well as price, has opened up a world of possibilities for us as market analysts. These cycle tools are different from the run-of-the-mill indicators in that they are not telling you "buy now" or "sell now", but indicate areas where market structure is likely to change. This is an important distinction that should not be overlooked when applying these concepts to your own work. Take a look at the chart below:
First off, let me apologize for the lack of trendlines, ellipses, and other drawing objects that usually appear on these charts. TradeStation 2000i does not work perfectly under Windows 2000, and most of the problems seem to occur when using drawing tools like trendlines. Just pay attention to the letters "A" through "D" and everything should be clear.
The light blue line right under price is our Cycle Forecaster working to predict a 14 bar MA_Momentum curve 7 bars into the future. Notice that 7 is half of 14, so we are working with a half cycle prediction in this case. The yellow curve underneath that is a 7 bar MA_Momentum curve, which represents the half cycle itself. It is important not to just throw random values into the indicators but to keep everything working with a particular market cycle when doing what we're about to do. Just to make things clear, we base our studies on a 14 bar MA_Momentum curve, and look ahead with the Cycle Forecaster one half cycle of this main curve. We then take the half cycle itself, a seven bar MA_Momentum, and display it below our prediction. The reason I'm making a big deal out of this is because by setting things up in this way we're harmonizing the indicators.
Now that we've got the parameters established, let's think theoretically about what is going on here. The Cycle Forecaster is analyzing the cycles in the MA_Momentum curve. When we see a turning point form, we know that the CF has determined that the underlying cycles in our momentum curve will change at that point in time. This usually means momentum will shift from up to down or vice versa. So we're trying to locate structural changes in the Momentum curve. We then can use our half cycle momentum to help confirm these indications and get a bearing on price
There are four interesting areas labeled on the chart above. We will look at each in turn:
A) This turning point in the Cycle Forecaster corresponds with bearish divergence in MA_Momentum and an Exhaustion Bar sell signal. We should be looking for the end of the uptrend at this point. It turned out to be a premature signal, but price didn't do anything to trigger an entry so we should have been safe here. Remember to use stops to enter the market when looking for turning points.
B) This is the same situation as in A, save we're missing an Exhaustion Bar. Notice how we don't really care which way the Cycle Forecaster is currently pointing. Only the fact that it has made a turning point really matters. Since these turns appear 7 bars ahead, we are always prepared for them when they arrive. The triple divergence in the MA_Momentum curve is a pretty strong signal here, and a trendline breakout would have been a good way to set this trade up. We were down for the rest of the day after this happened.
C) We've got bullish divergence between price and momentum here, as well as a CF turning point and an Exhaustion buy. The next day's break out over the congestion area was the buy confirmation and we ran up into the next point of interest...
D) Same situation. Bearish divergence, CF turning point, and an ExBar. Get out of the long trade and go short at this point.
Get the idea. It's the same set up over and over again. There are plenty of other turns that the CF caught, but none of them gave the crisp divergence signals that we like to see. We were waiting for confirmation between the half cycle forecast and the forecast itself for these trades, and sat on the sidelines when nothing showed up. Three trades in one week doesn't seem like much for a day trader, but after it was all over there was money in the bank and that's what counts.
Hopefully you've gotten some good ideas from this about how to use the new Cycle Forecaster in your own trading. This is meant to be a starting point for your own research. Just remember to link the lengths of the indicators as was shown here, and not get carried away with taking trades based on unclear signals. Stay tuned for more next time. Happy trading.
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