Price
Momentum
Volatility
Tops and Bottoms
Channels
Lower Lows and Higher Highs
For all price patterns, a key component in
determining the strength of the divergence is
based on the significance of the price pattern.
Significance is determined by the number of
candles to the left and the number of the candles
to the right of the price pivot
The more significance the price pivot, the
stronger the divergence setup
Filtering divergence setups by “strength” will
reduce the number of potential setups but
increase the probability of a successful trade
Price pivots can be identified with the use
of the Zig Zag indicator or Fractals.
Zig zag offers a visual representation of
market swings and is preferable to some
traders
The first price pivot is confirmed with the
• The significance of the price pivot is determined by the number of candles to the left and right. The minimum number of candles required is 2 to create “peakiness”. Only significant price pivots should be considered for divergence setups.
• Textbook examples of a double top and a triple bottom. Due to high volatility, tops and bottoms are often not restricted to a “pip to pip”
• Instead of using support and resistance as a line, it is more useful to define S&R in terms of a range to identify divergence setups. The wicks that are common to both price pivots make identification of the price range simple.
• Once the channel has been defined by two significant swing highs, it sets up four short negative divergent trades
• Lower lows and higher highs can be determined by fibonacci expansions and extensions. Critical fibonacci expansions are 112.7%, 127.2% and 161.8% of the impulse wave.
A
B
The wave is
between points A and B.
Look for market reversal at 112.7, 127.2 and 161.8 of the impulse
• Range charts are often easier to identify the significant swing lows and swing highs for the fibonacci expansion calculation. Note that fibonacci expansions ignore the retracement. A
• Fibonacci extensions are also very common, especially in markets in which have classically retraced prior to the final impulse wave. The most common fibonacci extensions are 50%, 61.8%, 76.4% , with the most common at the 100% extension.
A
B
Market reversals often occur at the
following key price levels:
• Pivot points, Previous day high and low, long
term support and resistance
Often the market reverses at the opening
of new trading sessions
Price
Momentum
Volatility
Momentum is a useful confirmation indicator of
market reversals
The drawback of most momentum indicators are
that they lag the market, rather than lead it
Momentum indicators can be used to identify
divergence, a leading indicator
Many indicators are useful for divergence, including
MACD, price oscillators, stochastics, and RSI
MACD is the most useful indicator for identifying
divergence but often takes too long to set up and too
long to confirm as a trigger
The zero lag MACD addresses this issue. It
identifies the ideal divergence setups
without significant market lag
RSI works well on a long range chart to
confirm divergence setups (cross with angle
and separation)
In conjunction with the ZL MACD,
stochastics or RSI work well to confirm
overbought/oversold conditions on short
term charts
• Zero lag is defined by calculating the EMA and then the EMA of that EMA. If needed, I can provide the NT code.
• The Zero lag MACD identifies crossovers
several bars earlier than the classic MACD and also denominates divergence more obviously
• The RSI works very well on a long term time frame as a trigger confirmation. Even the zero lag MACD gives too late of an entry on a long term chart.
The strength of the divergence is indicated in the MACD.
Ideally, the second wave retraces no more than 50% of the
first wave
Traditionally, classic MACD divergence is identified with
MACD peaks. Always identify divergence in a peak to peak
comparison.
Ensure “line of sight” (i.e., connect peak to peak without any
obstructions)
Traditionally, zero line MACD crossings were the best
confirmation of divergence; however, classic MACD gives
minimum examples of this. ZL MACD gives many more zero
line crossings to improve divergence “strength”. In general,
the closer to zero, the higher the possibility of a successful
divergent trade.
• Stochastics work well on lower time frames to confirm the divergence established on higher time frames.
• The stop is the same for both the aggressive and conservative entry. The entry price will depend on the experience level of the trader in recognizing the short term momentum indication and long term setup
Price
Momentum
Volatility
Bollinger bands provide two useful functions in trading
market divergence.
First, bollinger bands measure market volatility.
Statistically, price remains between the top and bottom
lines of the standard deviation bands. Market reversals
often occur at the band edges.
Second, the bands provide useful targets for divergence
trades, typically the most difficult to use price projections.
The first target is the the simple moving average. The
second target is the opposing band edge.
For this study, number of standard deviations is set to 2. The
period of the simple moving average is 20. Using an EMA
instead of a SMA is preferred.
• The entry is confirmed with the bollinger
band, needing to be at or exceeding the band edge. Target 1 is the simple moving average. Target 2 is the opposing band edge.
