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When new users take a look at Wave59 for the very first time, they often get upset because they expected the 9-5 Count or Exhaustion Bars to mark every turning point to the bar, with no false signals, and perfect accuracy. Unfortunately, trading isn't quite that easy! Along with good signals, we also have false signals and missed signals to deal with, and there's no way around that. Each indicator has certain conditions that it works very well in, as well as certain conditions where it doesn't work so well. Take a look at the Exhaustion Bars on the chart below:
This is a 3 minute chart of ESU6 for the last few days, which ended up as a relatively strong move downward where the market lost around 40 points. The Exhaustion Bars tended to issue a lot of buy signals during this period, as they were trying to pick bottoms during this move downward. The first reaction most beginners take is "This doesn't work at all! I'm going to cancel my trial and never come back!" and then they move on to the next toolkit that catches their eye, and the next, and the next... But if you take a closer look at the chart, you'll see that the Exhaustion Bars actually did work as promised. Their job is to mark turning points, which they did. The problem is not that the indicator isn't working, it's that a lot of the turns got washed out in the downward trend, and ended up just being small blips on the way down. We found our turns, we just need a way to tell whether they will be strong ones or weak ones.
The solution to this problem, as stated countless times on these pages, is to use multiple indicators to confirm each other. So rather than jumping in or out off of just the Exhaustion Bars themselves, let's use them in conjunction with something else. One tool that works really well for this purpose is our UltraSmooth momentum indicator.
What we are interested in with momentum is divergence signals, where the market makes a low, then a lower low, but momentum makes a low and then a higher low. Momentum moves up while the market moves down. Usually the market corrects in the direction of momentum in these situations, so it's very worthwhile to keep track of divergence signals. The chart above shows an example of what we are looking for. The market made a low at point A, rallied a bit, then declined into a lower low at point B. If you look at what momentum was doing at these two points, you'll see that it made an initial low around A, rallied along with price, then declined into a higher low at B. So it is diverging from price, as shown by the trendlines drawn on the chart, and this is a buy signal. It coincides with a blue Exhaustion Bar, giving us some confirmation. This signal was the first confirmed buy of our down move. The rest are shown below:
As there are a lot of bars on this chart, the momentum curve looks a bit squashed, but if you go through it you'll be able to pick out the momentum divergences as we've done on the previous chart. I've placed arrows in at the points where divergence signals lined up with momentum. You can see that just by adding this one filter, we are picking out much stronger buy signals than the Exhaustion Bars were able to do alone.
The sell signal at the top was obviously a good one, and then we had rallies of 6, 12, 10, 5, 12, 5, and 12 points, counted as we move from red arrow to red arrow. Those 5 and 6 point countertrend moves might not have given us much, but we definitely could have taken something out of the 10 and 12 point moves.
More importantly, let's take a look at the signals that we didn't get confirmation for:
The Exhaustion Bars shown in the colored boxes are the ones which had no supporting divergence signals. You can see that for the most part, these are the dots that showed up midway through a move, and in all cases but one would have been trades that were instant losers. By giving up just these seven signals, we have significantly improved our results, and this is a situation where we are only using two tools to confirm each other.
Hopefully this shows the power of using multiple indicators in parallel. The biggest moves will always telegraph across both indicators and time frames. You can get an Exhaustion Bar or 9-5 signal floating here or there that fail, but you hardly see it when a mass of indicators come together all at once. Using multiple indicators in this way is not a new thing to readers of these articles, but it's a very important concept, and one that when properly applied allows us to cherry pick only the best trading opportunities. Using just the two tools examined here in the correct way would have made us money over the last few days, and we would have been buying against the trend almost every single time! The tools are meant to be used together, not one at a time, and it's the combined signals that we are most interested in and which will give us the best results..
All for now. Thanks for reading, and happy trading!