Day Trading Stock Tip Lesson – Double-Divergences For Back-Testing Ideas

Day Trading Stock Tip Lesson – Double-Divergences For Back-Testing Ideas

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 truly shows that the indicator now has a higher value than the value 30 days ago. In this example 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 additional confirmation from another time frame. Since you should never trade live money without first doing some form of testing, consider adding in an additional 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 shared 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 past low), look at the RSI indicator. If it has a value of 29.50 you will observe that the indicator is truly HIGHER than it was at the past low price, already 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 the minimum be careful on any short locaiongs you may have in symbol ABCXYZ.

To get additional confirmation, consider looking at the 30 minute chart. If you notice another “positive divergence” on the 30 minute chart (in addition as the 5 minute chart), then consider your actions consequently. 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 enhance your trading results. As always, before committing any money be sure to back-test on the signs (or universe of signs) which you anticipate that you will trade.

If you have any questions at all, speak with a competent specialized financial advisor who can help you with your trading strategies. Remember that in all trading and investing, especially day trading, you risk losing meaningful amounts of money. Follow all standard financial disclaimers and use meaningful time on your risk and money management techniques.

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