Trade Type #1 = Trade from Fib Range to previous high/low (Fast trade, higher risk, lower profit)
Trade Type #2 = Trade from Trend Change to Fib Range (Most profitable and most common)
Trade Type #3 = Failed Channel Break to new high/low (hardest and most complex)
The example trade taken is from today, 7/21/2010. I have been holding cash in WSS (Wall Street Survivor, a paper trade site that is the closest site I've used that is like the real thing.) for the last several days waiting for a Type 2 trade setup. Today the criteria was met so even earlier than when I entered because I was on the way to work but I entered into the position at decent level.
Lets first take a look at the biggest picture. I look to all of the charts time-frame to see if I can use any information in the longer-term such as 50 & 20 Day MA's in this example. Once I make sure i'm not fighting any longer-term support/MA's/resistance/Trend channels, I take a look at my longest time-frame chart. In this case the 10 minute chart. I have been waiting for the run to start to lose strength and momentum to allow me to establish a short position near the top of the bull rally. As a foundation of the Divergence Trade of 3's, we use 3 consecutive chart time frames. For this trade example I used the 1/5/10 minute charts for the trade. Lets take a look at the 10 minute chart to see the setup more clearly.
As you can see from the 10minute chart above you had a typical run showing towards the end bearish divergence. This run took several days for it to play out and start to lose steam. I entered the position a little late because I was not at the computer during the initial trend channel break. From this trade you can see how the CCI broke -100 and I exited the position at the second break of -100. This is not a mandatory rule but, not exiting it at that point you would need a whipsaw to continue to make money. I am looking at an exit around the fib. retrace lines and I was fortunate to get a strong sell off very deep into the fib range. Once I met my target area, I waited to see bullish divergence on the down channel. Lets take a look at the 5 minute chart.
It is easier to tell that the down movement is losing power buy the bullish divergence in CCI, RSI, ADX. Also the Hist in the MACD is showing decreasing down movement and the STO showing a bottoming formation. At the point of exit we could continue on to another new low and still showing bullish divergence but, it was enough to protect my gains. Lets take a closer look at the trade, see the 1 minute chart below.
On the 1 minute you see the much more emphasized Bearish Divergence on the trend change down and Bullish Divergence when we are bottoming the down run. I have added a new indicator in recent weeks to help define chanels. See how you get a 4 & 24 EMA cross on entry of the trade and an additional cross at our exit. This is not always the case, but does help when we have a strong trend in progress.
To conclude Type 2 trades (trend change to fib range) is a very commen trade I use and can be applied to any 3 group time-frames.
