If you trade stocks online using a technical stock chart (such as a bar chart or Candlestick chart), chances are that you have heard about day trading stock strategies using “divergences.” A divergence is when you see prices making “relative” new highs or lows, but the corresponding indicator is not following the same action. An example might be if a certain stock made a 12-month low 30 days ago, but the technical indicator you use actually shows that the indicator now has a higher value than the value 30 days ago. In this instance there would be a divergence between the stock price’s action and the indicator’s action.
Many day trading systems incorporate divergences into their calculations, but many fail to get the extra confirmation from another time frame. Since you should never trade live money without first doing some form of testing, consider adding in an extra condition to your strategy when back-testing: have a larger time frame also show signs of a divergence in the same direction. The technical indicators you would use are oscillators, and the most common ones are Stochastics, Relative Strength Index (RSI), and Moving Average Convergence-Divergence (MACD). Consider looking at a time frame of 5 to 6 times greater than your intraday trading time frame.
Let’s use an example for this day trading stock tip lesson:
- SYMBOL = ABCXYZ (not a real symbol)
- Trading Time Frame = 5 minute chart
- Longer Time Frame = 30 minute chart (6 x the Trading Time Frame length)
- Lowest Price in last 30 bars was 23 bars ago (on 5-minute time frame) at $24.32
- 14-Period RSI 23 bars ago had a value of 21.00
Now, if the last bar made a new low at $24.20 (12 cents lower than the previous low), look at the RSI indicator. If it has a value of 29.50 you will note that the indicator is actually HIGHER than it was at the previous low price, even though the stock’s price is now LOWER. This is the “positive divergence.” Be alert for a possible reversal if market conditions are otherwise normal, or at least be careful on any short positions you may have in symbol ABCXYZ.
To get EXTRA confirmation, consider looking at the 30 minute chart. If you notice another “positive divergence” on the 30 minute chart (as well as the 5 minute chart), then consider your actions accordingly. Incorporate this second, longer time frame divergence as part of a new strategy to be back-tested. You may find that filtering divergences by having a second divergence may help you improve your trading results. As always, before committing any money be sure to back-test on the symbols (or universe of symbols) which you anticipate that you will trade.
If you have any questions at all, speak with a competent professional financial advisor who can help you with your trading strategies. Remember that in all trading and investing, especially day trading, you risk losing significant amounts of money. Follow all standard financial disclaimers and spend significant time on your risk and money management techniques.
Source by Matthew Mc Dermott www.positivestocks.com