A Quick Lesson in Trading Reversals from Support with Divergences

05/28/2015 6:00 am EST

Focus: STOCKS

Corey Rosenbloom

Founder and President, Afraid to Trade

Technician Corey Rosenbloom, of AfraidToTrade.com, highlights one of his favorite trade set-ups—the play into higher time frame support with lower time frame positive divergence—and shows how it developed Tuesday and how to apply it to future aggressive intra-day reversal trading opportunities.

One of my all-time favorite trade set-ups is the play into higher time frame support with a clear lower time frame positive divergence.

Let’s unpack these terms, see it as it developed Tuesday in the S&P 500 (SPX), and apply this lesson to future opportunities to trade aggressive intra-day reversals (the same logic would apply to any stock or ETF).

Here’s the Quote from Tuesday’s Update:

“The movement away from 2,130 set in motion today’s fall toward the 2,100 simple target we’ve been discussing.

At this point, the market has achieved a key downside target (2,100) on intra-day positive divergences so we’ll be on guard for a bounce up off 2,100.”

With that in mind—“key downside target on intra-day positive divergences”—let’s see exactly what happened:

chart
Click to Enlarge

Note the positive divergence…it simply means that price is making lower lows at the same time a momentum oscillator is making higher lows.

It’s a visual conflict—or non-confirmation—that suggests a likely reversal (instead of price continuing lower).

Indeed; note the “R” and green highlight which reflects a very aggressive reversal opportunity.

Buy as close as possible to the 2,100 level, preferably as price is pivoting up away from it and place a stop-loss under the 2,100 level in the event the strong downtrend continues (negating the divergence).

An additional trigger-buy would be when price crosses above a moving average (I use the 20 and 50 Exponential) or on the break above a hand-drawn trendline.

As was expected, price did pivot (reverse) up away from the 2,100 key level and we saw an instant 15 point rally off the 2,100 level.

This same logic—a Higher Time Frame Support Level with a Lower Time Frame Divergence—is one of my favorite combination patterns.

By Corey Rosenbloom, CMT, Trader and Blogger, AfraidToTrade.com

Related Articles on STOCKS