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Here is an excerpt from our trading plan.
Back in early May during the terrible tweet storm, we wrote about how volatility ($VIX $VXN) was not surging. There was no sign of true panic under the hood. Market internals were looking healthy. Only that trader sentiments were getting extremely bearish.
We wrote that this unique combination creates a bullish divergence, which can be highly profitable for bulls.
On Monday 6/3, Drop2 of the May Down Trend ended.
On Tuesday 6/4, $SPX $NDX $RUT launched themselves into Bounce2 which can be viewed as a typical corrective bounce of a down trend. However, it may very well turn out to be Surge1 of the new Up Trend, because of the Fed hinting at rate cuts.
Adam Grimes (author of the excellent TA book "The Art and Science of Technical Analysis"), wrote:
"This is important. In fact, it is the single most important point in technical analysis — the holy grail, if you will. Every edge we have, as technical traders, comes from an imbalance of buying and selling pressure. That’s it, pure and simple. If we realize this and if we limit our involvement in the market to those points where there is an actual imbalance, then there is the possibility of making profits. We can sometimes identify these imbalances through the patterns they create in prices, and these patterns can provide actual points around which to structure and execute trades. Be clear on this point: we do not trade patterns in markets — we trade underlying imbalances that create those patterns.”
Keep this in mind as you hone your own trading system and craft your trading plans. Our goal should be to use technical patterns and technical data to identify the underlying imbalances and trade them.
To focus on just the price actions of charts alone seems to be a bit short-sighted to us. Therefore we always try to look under the hood. That's where we can identify the underlying imbalances. And in our experience, these underlying imbalances can show up days or weeks in advance of a major move.
So anytime you hear "bullish divergence" or "bearish divergence", those are hints that there is a big underlying imbalance forming. They offer low-risk, high-probability, high-reward setups to trade.
So the questions to ask now are:
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