A lot of people ask me which tools would be the best ones to start out with. Although all the tools found on this web site are useful, some are definitely easier to use than others. Exhaustion Bars are the easiest to use, while the Cycle Forecaster is probably the most difficult. I hear back from a lot more people who have been able to integrate the ExBars into their trading method, than I do from Cycle Forecaster users.
The reason is that some traders just don't have the time or energy to learn the intricacies of how to interpret the Cycle Forecaster. (Those who have learned to use this tool always tell me it was well worth the effort.) So for those who prefer something that cranks out trades in a fairly mechanical way, this showcase presents a very simple approach using momentum and Exhaustion Bars.
I know a couple traders who use a very similar approach to the markets. One of them, and end of day stock trader, claims over 80% winners using a mechanical system based on the chart below. So pay attention - this method can be the basis for a great automatic system.
In order to take a trade, we are looking for two things to happen. The first condition is that price and MA_Momentum are diverging. As a quick recap, a bullish divergence signal occurs when price makes a lower swing low while momentum makes a higher swing low. A bearish divergence occurs when price makes a higher swing high while momentum makes a lower swing high. The idea is that momentum is a truer measurement of price action, and that price will correct in the direction of momentum when the two fall out of step.
The second condition is that we need to have an Exhaustion Bar present to take a trade. Note that the ExBar does not need to be on the last swing of the divergence. It can also be on the first swing low or swing high. Remember that momentum divergences require two swing lows (for buy signals) or swing highs (for sell signals). We need an ExBar on one of these swings to validate the divergence signal.
Looking at a chart will make this clearer:
This is a one minute chart of Microsoft for August 13. The red and blue dots above and below price are Exhaustion Bars, while the pink line at the bottom is a 12 bar MA_Momentum curve. Below is a blow-by-blow account of how this method would have been applied during this time frame. Use the letters on the chart to follow the commentary.
Point "A": When we talk of swing lows, note that all that matters are the turning points in the momentum curve, not price. First look for divergence. In this case, momentum clearly made a low, then a higher low. This is shown by the red trendline underneath the momentum curve. If you compare the price action at the corresponding times, you'll see that unlike momentum, it made a lower low during the second swing. This is a bullish divergence signal. There were two blue ExBars present, one during each of the momentum lows, so the signal was confirmed. You probably wouldn't have made money on this trade, but you wouldn't have lost it either.
Point "B": This congested period was a little tricky, but gave us two sell signals in a row. There was a triple divergence here, with a red ExBar dot at each swing high. Note that we don't care about the blue ExBars, since momentum wasn't making a bullish divergence. Another wash trade, if you even bothered taking it during the boring congested phase.
Point "C": There are four red ExBar sell signals in a row on this peak, but if you kept track of momentum and waited for a clear divergence signal, you wouldn't have jumped in too early.
Point "D": We've got momentum divergence here, and an ExBar on the first swing of the divergence signal. The second price swing doesn't have a corresponding ExBar, but that's OK. The ExBar at the beginning of the divergence signal validates this setup. Notice that the trend is also up (from 8:30), so we're buying a pull back to the main trend. You would have made money on this one.
Point "E": This trade caught the high of the day, and was about as clear as it comes. Two ExBars, one on each leg of the divergence signal. Also profitable.
So during the day, there were 5 signals. You might have lost a nominal amount on the first two, but that would have easily been made back on either of the last 2 trades of the day. Experienced traders might not have even taken those losses due to the boring nature of the market during the times those trades popped up. It was a one minute chart, but this approach is applicable to any market and any time frame.
Stops and exit strategies need to be worked out before hand, but this is an easy way to begin trading with these tools without having to learn too much in the way of indicator interpretation.
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