This Trading System/Methodology Revolves Around the Confluence of Technical Phenomena That
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Introduction This Trading System/Methodology revolves around the confluence of technical phenomena that is critical to and forms the essential basis of the System/Methodology, described as A-E below; Completing Tasks 1-3 below, in the way described in this document will enable a user of the Trading System/Methodology to trade with high probability and low risk.
A. Identifying what the prevailing market conditions are (trend or range)are by means of Overall Price Action – Classic Previous Price Swings Peak/Valley Analysis. (Task 1)
B. Identifying what areas in the market may provide Support or Resistance, and where Support may act as Resistance if breeched to the downside and tested from the other side (SBR,) and conversely where Resistance may act as Support if breeched to the upside and tested from the other side, (RBS.) (Task 2)
Once this analysis is complete, the aim is to identify Individual Price Action as the trigger at one of the technical indicator based set-ups/patterns that indicate a high probability trading opportunity, either with or against trend.
These technical indicator based set-ups/patterns are based upon;
C. Oscillator Divergence from Price/Extreme Oscillator Readings D. Price Band/Channel Deviation/Extreme Deviation from it’s mean. E. Identifying Individual Price Action as the trigger to entering the market.
Memorising these set-ups/patterns is Task 3.
Consistency is the key to longevity in any market. Professional traders wait for the probability of a successful outcome to be substantially weighted in their favour indicated by the confluence of technical conditions that suggest a high probability trading opportunity. The confluence of the 4 technical factors B-E, within the context of A, give rise to high probability trading opportunities.
The Trading System/Methodology analyses price across 3 time frames. The immediate / trigger, (hereinafter called the trigger time frame) the intermediate, and the higher/trend (hereinafter called the trend time frame.)
My own preference is to use the 1min, 5min and 30min as the trigger, intermediate and trend time frames respectively. The Trading System/Methodology can be used on longer time frames such as 1hr/4hr/Daily, or indeed 4hr/Daily/Weekly etc..
This underpinning 3 time frame approach is based upon, and is an obvious evolutionary step of Dr. Alex Elder’s methodology (Come into my Trading Room etc...) who looks for set-ups on the intermediate in the direction of the trend time frame, with entry fine tuned/timed on the trigger time frame chart.
The Trading System/Methodology can deliver attractive gains in any liquid market but demands of the user his active attention to and engagement with the market not least in the identification of the prevailing trend, potential Support/Resistance in the market, and the memorising of the Indicator based set-ups/patterns that enable high probability trading opportunities at such potential Support/Resistance/SBR/RBS. A. Overall Price Action - Classic Price Peak/Valley Analysis Price is the most efficient/purest indicator from which everything else is calculated.
In this section, I will deal with Overall Price Action-Classic Peak/valley Analysis. Through this analysis it is possible to determine whether price on any given time frame is ranging or trending.
A time frame is trending when a succession of obvious higher swing highs (HH) and higher swing lows (HL) results in an uptrend;
The opposing lower swing highs (LH) and lower swing lows (LL) occur in a downtrend, as pictured below; A trend on any time frame is said to be in question when, continuing with a downtrend example, the last LL then last LH of the downtrend is exceeded to the upside, from an area of support, directly or following an HL from it’s lowest point.
This is shown in the example below; a downtrend of lower highs and lower lows was in place on this time frame, until an equal high (EqH) to it’s last LH from support found at it’s lowest point was then succeeded to a HH following a HL indicating that the down trend on this time frame could be at an end for now. Indeed a 2nd Higher Low (HL) resulted in a second Higher High, (HH.) establishing then a new uptrend. In the further example below, this time an uptrend composed of classic HH’s and HL’s was quickly reversed by a low (L) which was lower than the last HH and HL of the uptrend before a further Lower High (LH) and Lower Low (LL) occurred, establishing then a new down trend. Using the example above, When the last HH and HL an uptrend is exceeded to the downside, it puts into question the prevailing uptrend on that time frame, and may indicate the beginning of a new opposing trend, or indeed a period of consolidation. The opposite holds true for a downtrend.
A time frame is ranging/consolidating when there is a random distribution of HL, HH, H, LL and LH and L ‘s as price consolidates and remains undecided about it’s next direction. An example is shown in the chart below; Task 1 involved with this Trading System/Methodology is to establish whether the intermediate and trend time frames are trending or ranging using the Classic Peak/Valley Price Action Analysis shown above.
This analysis of the conditions present on the intermediate and trend time frames is essential in making an informed decision in respect of any trading set-ups that may present themselves. Identifying a Re-entry set-up for example is highest in probability when at least the next higher time frame is indeed trending. B. Identifying Potential Support & Resistance
Support and Resistance is the one constant across all time frames, and across all trader classes.
When there is more demand than supply, price rises until they are once again balanced. When there is more supply than demand, price falls until once again the supply/demand balance is restored. We can also use this concept to explain support or resistance areas.
Let's first consider Resistance…Price rises while demand is greater than supply. As price rises though, it will become less attractive to the buyers, leading to reduced demand. And it will become more attractive to sellers, leading to increased supply. If the supply/demand ratio can be tipped in favour of supply, price will fall.
Resistance is simply an area which has shown past evidence of halting a price rise. Price hits the resistance zone, and turns around to fall again. If it helps, think of resistance as a ceiling that resists any further price rise.
Support works much the same. Price falls while supply is greater than demand. As price falls though, it will become less attractive to sellers, leading to reduced supply. And it will become more attractive to buyers, leading to increased demand. If the supply/demand ratio can be tipped in favour of demand, price will rally.
Support, then, is simply an area which has shown past evidence of stopping a price fall, and leading to a price rally. If it helps, think of Support as a floor that supports price.
The aim of identifying areas of Potential Support and Resistance is to find the areas at which there are likely to be sufficient market participants/volume of orders to move the market so as to produce a gain should a set-up present itself on the trigger chart and upwards (confirmed by individual price action.) On an intraday basis the aim is to identify the areas where the big/institutional/smart money waits to act.
In identifying areas at which there may exist potential for Support or Resistance sufficient for price to reverse it's immediate direction, there are three (4) main factors to look for:
1. Previous price swing Hi or Lo areas 2. Fib Retrace areas. 3. Bids/Offers information (MNi / Thompson/Reuters etc..) 4. 1hr + ascending Support TrendLines / descending Resistance TrendLines.
The Daily Pivots (Daily S3 through Daily Pivot to Daily R3) can be useful too as part of any confluence of potential Support or Resistance. These sites will confirm where the pivots are located, the first of which having a facility to alter the time at which they are calculated; http://www.mataf.net/en/forex/trading/pivot-points/standard/ http://www.actionforex.com/forex_analysis_and_forecasts/pivot_points/
Of course the custom indicators will plot them on the charts if required. Weekly and Monthly Pivots, as well as Mid Pivots (on any time frame) if used, should all be treated as secondary factors in any consideration of potential Support/Resistance.
The starting point in identifying Potential Support/Resistance/SBR/RBS, and Task 2 of this Trading System/Methodology is to identify; a. Previous Swing Hi/Lo Zones on the Trend time frame. b. The nearest intermediate Previous Swing Hi/Lo Zone on the intermediate time frame.
(Noting and updating these Zones as price action develops.)
Then,
Noting whether any of the other factors that may cause Support or Resistance, (listed as 2, 3, and 4, above) occur in each Previous Swing Hi/Lo Zone.
How to Identify The Zones present at the Previous Swing Hi/Lo areas is shown below; i. The potential Resistance or RBS zone of any previous Swing Hi area like point X shown in screenshot below consists of the point between the highest candle shadow/spike to the highest price close of the candles that form that overall previous Swing Hi area.
A Previous Swing Hi zone should be viewed as Potential Resistance if being re-tested from the underside and as Potential RBS if being re- tested from the upside-following a pullback in an uptrend. ii. The potential Support or SBR zone of any previous Swing Lo area like point Y shown in screenshot below consists of the point between the lowest candle shadow/spike to the lowest price close of the candles that form that overall previous Swing Lo area.
A Previous Swing Lo area should be viewed as Potential Support if being re-tested from the upside and as Potential SBR if being re-tested from the underside, following a pullback in a downtrend.
It is advisable to make a separate note of these Potential Support/Resistance/SBR/RBS areas and in so doing, if using the 30min as the trend time frame, do so using the 1hr time frame as the proxy for the 30min trend time frame. (For all other time frame combinations the trend time frame need not be changed for the purposes of identifying Potential Supp/Res/SBR/RBS Zones.)
Looking at the Previous Swing Hi/Lo Areas that form the basis of the Potential Supp/Res/SBR/RBS Zones on the 1hr chart may resemble the screencap below; In order to identify the Previous Swing Hi/Lo Areas that form the basis of the Potential Supp/Res/SBR/RBS Zones on the intermediate chart it is possible to do so using the Crosshair Tool on the MT4 charting, and/or a separate note can be made if it proves of assistance.
Note that in identifying Potential Supp/Res/SBR/RBS Zones, the technical Indicators based set-ups should always be sought oon the time frames below that of the Potential Supp/Res/SBR/RBS Zone.
Per this Task 2 pre-identifying these Previous Swing Hi/Lo Zones on the trend and intermediate time frames and then noting what other Potential Support/Resistance factors occur within them for further confluence results in the Potential Supp/Res/SBR/RBS zones present in the market, being known in advance.
Example:
The chart screenshot below shows an example of the confluence of all 4 Potential Resistance/SBR factors in play (circled in red.)
Price had reached a Previous Swing Lo Zone (ie previous Support circled in green) and the resultant Potential SBR zone at that Previous Swing Lo is shown in between the horizontal dotted white lines. In that zone was a 38.2% fib retrace of a longer term fall from a Swing Hi to the Lowest Swing Lo seen on the chart @ 6779. MNI had also touted ‘medium offers’ in the 7175/85 region, and there was also a 1hr descending Resistance Trend line in the Potential SBR zone (joining the Swing Hi’s marked with yellow circles.) At this Potential SBR/Res Zone a Reversal set-up was identified on the 1min trigger with a supporting 5min intermediate chart set-up. This confluence of set- ups across these 2 time frames gave a high probability trading opportunity. Price duly sold down 320pips from the 7177hi.
Having completed Task 1 and Task 2 a user of this Trading System/Methodology is aware of the prevailing conditions (trend or range) on the time frames he is trading as well as knowing in advance the Potential Support/Resistance/SBR/RBS that exists in the market.
The next task, Task 3 is to recognise one of the technical indicator based set- ups/patterns at one of the pre-identified Potential Supp/Res/SBR/RBS Zones.
Before detailing each set-up/pattern it is useful to explain the technical phenomena behind the 2 components of the set-ups/patterns, that of; i. Oscillator Divergence from Price/Extreme Oscillator Readings ii. Price Band/Channel Deviation/Extreme Deviation from it’s mean. C. Oscillator Divergence from Price/Extreme Oscillator Readings
Most technical indicators look back to calculate their present value and as such are 'lagging indicators.' The only way to use a lagging indicator as a potentially leading/predictive indicator is when it diverges from the price action. It is oscillator divergence readings / extreme oscillator readings that forms the basis of the essential first component of the indicator set-ups/patterns.
Oscillators measure momentum, so any divergence from price action in such an indicator suggests an exhaustion of the current price action direction and momentum.
There are different patterns of oscillator divergence, some potentially stronger than others, and they are broadly classed as: i. Regular Divergence - which can indicate a reversal/pullback in immediate prevailing price action. ii. Hidden (sometimes called Reverse) Divergence - which can indicate a continuation in a trend following a pullback (the pullback possibly highlighted by Regular divergence.)
These can be further sub-divided as: a. Regular immediate [separate oscillator peak/valley] Divergence b. Regular immediate [within same oscillator peak/valley] Divergence c. Regular sequential Divergence d. Hidden (Reverse) Divergence e. Oscillator Extreme readings.
These are illustrated further below; a. Regular immediate [seperate oscillator peak/valley] Divergence
The screenshot below shows an example of this type of divergence… Notice that in Osma, there are no intervening valleys between the 2 shown at either end of the red diagonal line and that the second valley was higher than the first whilst price was lower. This is the essence of regular immediate (separate valley) divergence. This is of course a Bullish example of this kind of divergence that can occur in a downtrend/range. The following example shows Regular immediate (separate peak) Bearish divergence in Osma that can occur in an uptrend/range.
Summary: Regular immediate (separate peak/valley) divergence is valid when oscillator makes a lower/higher peak/valley whilst price makes an equal or higher/lower hi/lo respectively. b. Regular immediate [within same oscillator peak/valley] Divergence
This is is clearly visible in the same peak/valley of the oscillator. I.e. The oscillator has not crossed it’s zero axis and back again to form a new peak or valley as in the case of regular immediate (separate peak/valley) divergence.
The screenshot below shows a bearish example of this divergence in the Osma and CCi whereas the oscillator made a lower read in the same peak as price made a higher high.
There follows a bullish example of this type of divergence in the Osma and CCi. Summary: Regular immediate (same peak/valley) divergence occurs when oscillator makes a lower/higher read within same peak/valley whilst price makes an equal or higher/lower hi/lo respectively. c. Regular sequential Divergence
This occurs when the divergence in the oscillator between peaks/valleys are separated by other peaks/valleys that may not show divergence with the one being created at the potential Support/Resistance by the immediate price action, but there is divergence in the overall oscillator sequence with price.
The example below shows Regular sequential separate valley Bullish divergence in Osma that can occur in a downtrend/range.
Note how there is divergence from price between the valleys 1 and 3 but not between valleys 2 and 3….overall though the sequence of the oscillator valleys is diverged from price, ie between valleys 1 and 3.
The example below shows the opposing Regular sequential separate peak Bearish divergence that can occur in an uptrend/range. For regular sequential divergence to be valid there should really only be a maximum of 3 peaks or valleys involved on the Macd ( 1, 2 and 3,) the sequential divergence measured between 1 and 3.
Summary: Regular sequential divergence occurs when in a sequence of maximum 3 peaks/valleys, there exists clear bearish/bullish divergence between peak/valleys 1 and 3. d. Hidden (Reverse) Divergence
This divergence occurs after a pullback in trend and can indicate an opportunity to rejoin the prevailing trend.
Hidden divergence in a downtrend occurs when after a pullback, price makes a lower high than the last price peak, as the oscillator makes a higher reading respectively. This is Berarish Hidden Divergence.
The example below shows Bearish Hidden Divergence in a downtrend;
Shown below is the opposing Bullish Hidden Divergence that can occur in an uptrend. Price is making an equal or higher swing low following a pullback in trend, but the oscillator is making a lower swing low. Summary: Hidden divergence sets-up after a pullback in trend when; i. In an uptrend, price makes an equal or higher low as the oscillator makes a lower valley. ii. In a downtrend, price makes am equal or lower high as the oscillator makes a higher peak. e. Oscillator Extreme readings
Extreme oscillator readings can occur in an uptrend, downtrend or range and generally indicates that price is overbought or oversold on the time frame on which it occurs.
Generally speaking the CCi oscillator will have ‘hooked’ back from an extreme reading outside it’s own bol, and in effect be showing regular same peak/valley divergence when the other 2 oscillators (Osma and Macd) reach an extreme. This is clear in the oversold example above. There follows an overbought example; Summary: Extreme oscillator readings can occur when price is overbought/oversold on the time frame they occur.
Summation: This trading system/methodology identifies very clearly the strongest patterns of Oscillator Divergence/Extreme reads that when combined with the Band/Channel Deviation and Individual Price Action as the trigger, (at pre-Identified areas of Potential Support/Resistance/SBR/RBS) indicate the highest probability set-ups.
Generally speaking Regular immediate / sequential divergence/ extreme reads in the oscillators are used as part of an indicator based set-up/pattern that may indicate a potential reversal/pull-back in the immediate price action on the t/f which they appear, and at least the one above that. Hidden (reverse) divergence helps to highlight possible high probability areas at which to re-enter the trend prevailing on the higher trend time frame, following a pullback.
This distinction between Regular and hidden divergence is very important.
Oscillator extreme readings suggest overbought or oversold conditions on the time frame on which they appear, but when a market is trending these oscillator readings will stay at overbought or oversold levels. Oscillator extreme readings only really become valid at areas of potential Support/Resistance/SBR/RBS.
The technical indicator based set-ups used per this Trading System/Methodology are for the first part based around the patterns/types of divergence/extreme oscillator readings.
D. Price Band/Channel Deviation/Extreme Deviation from it’s mean.
There are several technical measures of volatility in the market, volatility being a measure of the extent of price movement. Bollinger bands are a measure of volatility being a Hi and Lo band plotted around 2 standard deviations of a moving average. When a market is trending it is always deviated from it's average/moving average, and it follows therefore that when a market becomes extremely deviated from it's average/moving average then a pull back can be expected toward it's average/moving average at some point.
The example below shows that price is extremely deviated from 3 of the 4 Bollinger bands seen, and indeed a whole bearish reversal candle closes outside the 60 (lime) 40 (pink) and 20 (white) and straddles the shortest of them, the 10 setting bol (aqua.) from which price is deviated. A snap back inside the Bollingers results.
The example below shows again a whole reversal candle closing outside the 20bol, and this and the above is a common occurrence, indicating that price is extremely deviated from it’s averages. It is rare to see a whole reversal candle close outside the 10bol, but not entirely uncommon. Think of the middle line (the moving average) of the Bollinger band as a piece of elastic that when caused by price deviation to reach it’s maximum point of elasticity is likely to cause price to snap back inside the upper or lower band.
The default 20 period, 2 standard deviations setting of Bollinger bands contains 90-95% of price action within it so if price exceeds it's upper and lower ranges a 'snap back' inside the extreme hi or Lo band toward it’s moving average can be expected at some point, as in the example above
The technical indicator based set-ups used per this Trading System/Methodology are for the second part based around the pattern that the Bollinger bands make when price deviation/extreme deviation occurs.
E. Identifying Individual Price Action as the trigger to entering the market
Within the technical indicator based set-ups, individual Price Action is the actual trigger to entering the market.
Essentially it is a real reversal candle that is sought with entry made at it’s close. It is this Price action that is the trigger and the final part of the confluence in entering the market.
There are plenty of educational resource websites as well as the trading forums to inform a user more in respect of potential reversal candles. This document assumes a basic knowledge of Price candlestick analysis so that potential reversal candle types; Harami, Doji, Hanging man, Hammer, Evening star, Abandoned Baby Gravestone Doji, etc should be known to a user of this Trading System/Methodology. Charting
My own preference is to use MT4 Charting. The Main Charts across all time frames are basically the same;
The Main chart used across all time frames utilises Support/Resistance Channels and Bollinger Bands in it’s price window.
The Osma oscillator is utilised as the Lead Oscillator, with Macd as the secondary oscillator. I make use of a 3rd oscillator too, the CCI plotted around a 20Bol.
Putting these all together results in the Main chart on all time frames looking as below; There is the option to have a second Small chart running along side the Main charts. Sometimes when a Main chart trigger set-up appears but there is no supporting intermediate main chart set-up it can be useful to have some further technical confluence….the Small charts aim to provide this and detailed below; There are 3 Fib Tunnels on the Small charts for different levels of market volatility. Each Fib Tunnel has an Upper and Lower extreme. The Small chart above shows a breech of the 2nd extreme Fib Tunnel as well as the upper Donchian channel. Such a set-up added to the technical confluence of a Reversal Set-up on the corresponding Main chart.
I use these Small charts for the trigger and intermediate time frames, positioned alongside the Main charts. On the 5min Small chart I have the Fib Channels as a further indicator (yellow and aqua lines shown in charts below) and a breech of these can also be a good indication of overbought or oversold conditions particularly if; a. The Upper Fib Channels are descending into price at a potential SBR / Resistance area b. The Lower Fib Channels are ascending into price at a potential RBS / Support area Examples of this are given below;
Price breeches the ascending lower Fib Channel and first extreme lower Fib Tunnel; Price breeches the descending upper Fib Channel and first extreme upper Fib Tunnel and upper Donchian Channel.;
These Small charts are entirely optional. The technical Indicator based Set-Ups
Once the prevailing Overall Price Action conditions (trend or range) have been established on the intermediate and trend time frames (per Task 1) and the potential Support/Resistance/SBR/RBS zones are known (per Task 2,) Task 3 is to identify one of the repeatable high probability technical indicator based set- ups/patterns at such zones.
These set-ups/patterns are based upon the technical phenomena of oscillator divergence/extreme reads coupled with band/channel deviation. The further confluence of these two technical occurrences @ pre-identified potential Supp/Res/SBR/RBS zones with the entry trigger of confirming Individual Price Action, - within the context of the prevailing market conditions, give rise to high probability trading opportunities, and the trading edge provided by this Trading System/Methodology. Mark Douglas (Trading In The Zone, The Disciplined Trader) decsribes a trading edge as ‘…having an historically higher probability of one outcome over any other.’ To this extent all that is known about a trading edge is that historically over a sample it has repeated itself leading to over-all profitability. As the mouse is clicked to enter the market when a recognised trading edge presents itself (all rules/conditions associated with that edge being satisfied) it is not nor cannot be known in advance what will happen next. (‘The only certainty is uncertainty.’ Mark Douglas) Because the outcome is not known....it is inadvisable to get hung up on the result...it is a statistical occurrence in a sample of set-ups that meet the rules/criteria/conditions of the trading edge, and if the the trading edge is profitable across historical samples it has a good chance of being so again.
The set-ups are divided into 2 distinct categories, as under: a. Reversal set-ups (against prevailing trend) b. Re-entry (to trend) set-ups
Parts II (Reversal set-ups) and III (Re-entry set-ups) of this Trading System/Methodology detail the exact technical indicator based set-ups.