Being trading tool vendors, we tend to come into contact with many different traders, both successful and unsuccessful. The interesting thing about the successful traders is that each one will find a unique way to use our tools in their personal trading strategy. The exact same trading tool, with the exact same parameter settings, can be applied successfully in totally different trading strategies. There is no one way to trade a given tool, just as there is no one way to trade a given market. There are successful pattern matchers, wave traders, and even random walkers. Markets have multiple solutions, which is one of the more interesting philosophical aspects to trading.
This week, we decided to demonstrate how our indicators could be used in a different way. Although there is much more subjectivity in this approach than what has been shown on these pages in the past, this method should have appeal to those kinds of traders that tend to favor oscillators as their main timing tool. Below is a 10 minute Coffee chart of the last seven days:
This chart has three indicators applied to it: Exhaustion Bars, MA_Fractal, and MA_Momentum. We have circled areas of interest and labeled them from 1-6. A discussion of each area follows:
This is an area that is at the end of a dull, go nowhere market. The whole day of the 30th was pretty boring for Coffee traders, and MA_Fractal showed this very clearly by hugging the zero line in a very narrow range. Anytime you see this pattern in MA_Fractal, it is a clear flag to stay out of the market and preserve capital. Why trade when there is no trend? However, once MA_Fractal breaks out of this base things do tend to get interesting. If you think of the market as a spring, it is fully coiled and ready to explode after these kind of base patterns. MA_Momentum fell below zero right before this breakout, so alert traders knew to go short that day.
This area is interesting because an Exhaustion buy signal occurred at the same time as a bullish divergence signal in MA_Momentum. Prices were up at the following opening and a trendline drawn from "1" to "2" would have been broken later that day. This meant get out of shorts and go long, especially once MA_Fractal topped out.
Here is an example of why it is important to use multiple indicators to confirm or deny setups. Notice that we had bearish divergence in MA_Momentum at this time, telling us to look for shorts. The reason that this was a bad idea is because MA_Fractal was making a rising bottom, indicating that the trend strength was increasing. Divergence signals are meant to signal the end of trends, and try to catch turning points. We want the trend to be weakening, not strengthening to fade the market. If we were cautious, we might look to liquidate the long from area 2, but we wouldn't want to buck the trend and go short here.
An Exhaustion sell has popped up, warning us of a possible top. This might have been a good time to get out of long positions from circle 2. The problem with going short here is that there is no immediate confirmation from MA_Momentum or MA_Fractal. Later that day both of these indicators fell, but notice how price started moving up almost immediately after the ExBar. MA_Momentum and MA_Fractal came back as well, and everything started moving higher again. Conservative traders using stops would never have gotten a chance to go short, and aggressive traders that jumped in with market orders after the ExBar knew to get out once this happened. Elliot Wave counters will recognize this indicator behavior as somewhat typical after a wave 3 advance.
The first signal that occurred in this area was another Exhaustion sell signal. After that there was a short blow off rally to the highest point on the chart. Notice that the lows of previous bars were not broken after the ExBar sell, which told traders to wait for confirmation. At the top, MA_Momentum gave a nice divergence sell signal, and MA_Fractal diverged throughout the blow off move. The trend was at an end according to all of our indicators, so it was time to go short. There was a large range bar after the high that took out three previous lows, so most traders would have entered somewhere during that bar.
The last area of interest is also the most confusing to deal with on a real time basis. There was an ExBar buy, but an incomplete divergence signal on MA_Momentum (missing 2nd trough). However, MA_Momentum was increasing during this time, and MA_Fractal was bottoming so some traders probably would have gone long, or at least gotten out of their shorts from the high. Any traders who did go long were stopped out during the next 2 bars, so it would have been obvious that they had jumped the gun. Patience is important in trading. A bullish divergence signal did form, and MA_Fractal made a complementary base to this signal. Note the white trendline declining along the recent highs. If price can break above this line Monday morning (preferably off of a ExBar buy), a long position will be called for.
So we have just analyzed six trades in six days using these tools. The techniques are not complicated, but they do require patience and discipline. This kind of analysis would have lead to profits had the trader been able to control his emotions during the trading day. Never underestimate the power of fear and greed when it comes to contaminating real time trading decisions. This is the hardest part of discretionary trading. Practice with the indicators will lead to better decisions and fewer mistakes when money is on the line. Lastly, never forget risk management. Stay tuned...
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