Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
How to Find Areas of Support Using Multiple Time Frames
01/10/2011 11:07 am EST
Recent price action in the S&P 500 ETF (SPY) provides an excellent example of how alert traders can spot support and resistance areas. I think it’s important to document interesting examples of trading concepts played out during the day, as it serves both as an educational reference and deepens our knowledge about these concepts, which helps us to trade better the next time a similar set-up or opportunity unfolds in real time.
A great educational example—and good follow through—formed on the January 4 intraday reversal play that was telegraphed well in advance by various factors, some of which I wanted to show you so you can use them as a reference.
1. Higher time frame dual support played out on the intraday time frame (five-minute chart), and…
2. The intraday positive dual divergences that formed that preceded the official reversal
Both of these signals combined to give a trade entry trigger for a great intraday opportunity that actually carried into the next session.
Let’s take it step by step and learn from this example:
I want to cut right to the heart of the lesson and call your attention to the dual support line at the $126.20 level in SPY.
That’s because the level was a prior resistance point at the end of December (shown above), as old resistance sometimes becomes future support as price tests this polarity level again.
Beyond that, we have the 61.8% Fibonacci retracement drawn from the December 31 swing low near $125.30 to the January 1 $127.60 level. The 61.8% grid level came in (surprise) at the same level as the prior price high at $126.20.
As price pulls back, that’s a natural target to play for when shorting intraday, and a natural place where the market might turn around and find support if the swing continues down to that level.
So, concept one: $126.20 was a natural dual support target to play for short, and see if a reversal formed intraday.
And on January 4, that’s exactly what happened. Price fell off the open down to the $126.20 target level, so now the game changed to “Will support at $126.20 hold?”
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More importantly, with that target in mind, you should be watching the intraday structure in real time to see if there are any clues—such as divergences—that lead you to believe one way or the other that support will hold or break.
It turns out there was a powerful clue that then set-up a trade entry to play for the reversal and bounce up off support.
It’s one of my favorite concepts: Dual intraday divergences.
Now let’s take this one step at a time, focusing specifically on the dual divergences at 11:45 am CST at the $126.20 level we referenced above from the five-minute (and really any higher) time frame.
I discuss this concept frequently, but it’s always fun to look at new examples and trade them.
As price fell through the morning session, $126.20 was the higher time frame dual price and Fibonacci target. The market was an intraday short until then.
However, as price tested this level at 11:30 am, it became clear to those watching that a triple positive TICK divergence—along with a positive momentum divergence in the 3/10 oscillator— formed at this key price level.
Remember, we watch price first and then look to indicators to confirm or disconfirm what’s happening in price. Divergences are non-confirmation signals of a move in progress and suggest a retracement or perhaps a reversal is perhaps yet to form.
Look closely at the vertical highlighted line to see the inner workings of this dual TICK and momentum divergence.
At a minimum, that’s a “cover-your-short” position, and then see if a corresponding price breakout signal forms for you to play a reversal/long here. It did.
After the initial bounce off $126.20, price broke a rising trend line at $126.30, then, perhaps more importantly, it shattered through the 20- and 50-period exponential moving averages (EMAs) on the one-minute chart where I labeled it.
The official trigger happened at $126.40 for the entry to play long for an intraday trend reversal, which was made all the more better by the higher time frame dual support at $126.20.
Immediately after the breakthrough, and actually just before it, the TICK formed new intraday highs in what I like to call a “kickoff” or “Wyckoff sign of strength” signal that further increases the odds of a trend reversal.
It’s important to know these concepts—divergences and TICK kickoffs—in advance (study them) so you can recognize them in real time and play them appropriately when they develop.
In summary, and in chronological order, we observed:
1. Dual price and Fibonacci support at $126.20
2. Test of $126.20 intraday as clear dual positive momentum and TICK divergences form
3. Price breakthrough of falling trend line and one-minute EMAs
4. “Kickoff” signal in TICK via new TICK highs as price came up off the low
Taken together, the weight of the evidence favors short-term reversal, allowing you to trade confidently with the evidence from the charts.
From here, price went back up to form a new high at $127.80, as of January 6 when I’m writing this post.
For reference for those of us who are futures traders, here’s the same one-minute chart above of the @ES futures contract:
Remember, the more we learn from actual examples—particularly if we keep our own notes and observations—the more confident and better prepared we will be to capitalize on these opportunities when they repeat in the future...and they will.
By Corey Rosenbloom, trader and blogger, AfraidToTrade.com
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