MACD TRADING SYSTEM BREAKDOWN
Breakdown of SPY downside divergence setup:
This was a great pattern setup on SPY. We had a very clear downside divergence on the daily
chart with the MACD blue line below the signal line. This is what we call a High Probability
Pattern. As we start to move down in the time frames, we find that the first time frame to start
breaking down in the direction of our opportunity is the 30 minute chart. While we wouldn’t
have used this 30 minute chart for our entry point, is did help build the case that a move to the
downside was becoming more likely. Let’s look at the 15 minute chart below to view our entry
point.
The 15 minute chart is the time frame that provided us our best point of entry. Not only was
the price continuing to move higher while the MACD was continuing to move lower, the price
made a very clear double top with a MACD downside divergence below the signal line. This
provided a very precise, high probability entry point when the price reached its previous top
again. Stops would have been $.25-50 above the first top depending on your risk profile.
Break down of high probability set up on NFLX 4 hour chart:
This was a beautiful set up on NFLX’s 4 hour chart. You can clearly see the upside divergence
above the signal line on the 4 hour chart. But what makes this trade have an even higher
probability of success is that the divergence formed right at the 200 Moving Average. These
moving averages typically act as good support and resistance levels on their own, so to have the
price at a major moving average WITH an upside divergence on a higher time frame makes it all
the better. Entry would have been anytime the lower time frames started to build strength in
the direction of the 4 hour divergence, as seen on the 15 minute chart.
Breakdown of retracements during a trend on SPY Daily and Hourly chart:
This knowledge will help us with two things. Exit points and continuation entries. As you can
see on the chart below, the SPY daily MACD creates a strong move to the downside. While the
MACD points down strongly, the price starts to get away from the 8 day moving average. If
you’re a short term trader, this is the point where you want to consider selling if you took a
short position or bought put options, as the price will always, at some point, return back to the
8 and 21 moving averages.
Depending on the strength of the move will determine whether a divergence in the opposite
direction on a lower time frame will be required to create a sustainable retracement. In this
case, because the move to the downside was very strong and the daily MACD continued to
point down as the hourly tried to move up, a series of divergences on the on the hourly chart
were created to move the price back up. Once we see these divergences starting to form, we
can predict with confidence that a retracement is coming soon.
This also alerts us to a potential continuation trade once the divergence has played out. You can
clearly see that once the time frames below the hourly, stopped fueling the hourly divergence,
and the daily and hourly MACD turned back down, the price quickly returned back to the
downside. This is also when the price was hovering around the 21 day average (daily chart).
Now because there is no significant downside divergence on the daily chart, it comes as no
surprise that the price has now moved back up since this example. However, this example
provides a great reference point for understanding retracements within a trend and when the
price will turn back in the direction of that trend, giving us a better foundation for entering
continuation trades.
Breakdown of APOL continuation trade:
On the monthly side of the chart below, you can see that the MACD is moving up, no longer
trying to drag the price down. This makes the potential for an upside move much easier and
more significant because it’s not in the way of the weekly chart that’s trying to move up.
On the weekly side of the chart, you can see a significant upside divergence above the signal
line with the MACD pointing up. So the weekly is the time frame that has created the upside
opportunity. We now need confirmation of entry from the time frames below the weekly. Lets
take a look.
On the daily side of the chart below, you can see the 8 day average crossing the 21 day average
strongly and the MACD turning up strongly. This is confirmation that the weekly strength is now
being fueled by the daily chart.
When we look at the hourly side, we get a clearer point of entry and a look at what kicked the
price into motion. You can see on the hourly chart how the price is bouncing around on the
same level before it takes off, but the MACD is moving up building strength, creating an upside
divergence. Even though it’s not a V-shaped pattern, because the weekly is so strong, this was a
good enough pattern to kick the price into motion.
We needed a pattern like this on the hourly chart to kick the price into motion, as opposed to
just the hourly turning up, because the daily chart had been broken down pretty good. The
MACD on the daily chart had crossed below the signal line and the 8 day average crossed below
the 21 day average. This signifies difficulty getting the price into motion to the upside. So to
give us more confidence in the trade, an upside divergence on the hourly chart was necessary.
Our entry point was right where the arrow is pointing on the hourly chart. It was at that point
where the hourly MACD continued to move up and the 8 day average crossed the 21 day
average.
Breakdown of TBT continuation trade:
This is the second continuation trade opportunity that we’ve seen recently on TBT. The monthly
and weekly charts for this trade were about the same as the charts in the example above, a few
pages back.
A very similar setup took place during this opportunity as it did on the TBT example prior to this
one. You can see that the MACD on the daily chart had broken down pretty good again,
crossing below the signal line, requiring an upside divergence on the hourly chart to kick the
price back into motion. This is precisely what happened.
You can see the upside divergence on the hourly chart pretty clearly. The price makes a new
low while the MACD makes a new high. This caused the price to gap up, effectively giving us a
cross of the 8 and 21 hour averages, and turning the daily MACD up again.
We did not enter on the gap up (we never enter on a gap with this trading system). We waited
for the pull back to the 8 hour average, and then entered. The next day, it gapped up once
again, and resulted in a nice profit on the call options.
Breakdown of SHLD pattern setup + entry:
SHLD is a picture perfect setup. You can clearly see the upside divergence on the weekly chart.
Now because the MACD blue line is below the signal line pretty significantly, this indicates
weakness in the pattern, requiring a divergence on the daily chart to kick the price into motion.
You can see on the daily chart, as the daily MACD was forming the divergence, there was a
series of small up moves in the price whenever the MACD blue line turned up, and even a time
when the 8 day average crossed above the 21 average. This move did not last long and actually
reversed back to the downside very quickly because of the weakness in the pattern on the
weekly chart (MACD blue line below the signal line). This is why a divergence on the daily chart
was necessary. We need that daily divergence to counteract the weakness in the pattern on the
weekly chart.
Once the divergence formed on the daily and the 8 day average crossed above the 21 day
average again, the price took off with a vengeance!
Breakdown of APOL continuation trade #2:
This is the second continuation opportunity we’ve had since we started following APOL.
Following the guidelines above, this should have been a fairly easy trade to make.
You can see that the MACD on the daily chart is below the signal line. This requires an upside
divergence on the hourly chart for maximum confidence, because the MACD has broken down
on the daily chart. We need something with enough force to counteract that short term
weakness on the daily chart to kick the price back up.
This is exactly what happened. A very nice upside divergence above the signal on the hourly
chart was formed. This was enough to turn the price back up, giving us nice confirmation of
entry when the 8 hour average crossed above the 21 hour average. This resulted in a few
hundred percent return on the call options.
Breakdown of IBM continuation trade to the downside:
The downside divergence on IBM’s monthly chart has provided multiple opportunities, and this
example is just one of them. The monthly chart is what created our opportunity. The weekly
chart crossed months ago, giving confirmation for a longer term swing trade. But recently,
there was a nice setup for a continuation trade. Let’s look at the next chart.
Below is a double chart containing IBM’s daily and hourly charts. With the higher time frames
still indicating an overall downtrend, the downside divergence on the hourly chart below, with
it’s subsequent cross of the 8 and 21 hour averages, gives us a nice point of entry for this
continuation move.
The hourly divergence is what turned the MACD blue line back down to refuel the higher time
frames. We call this hourly divergence a “catalyst” to get the price back into motion in the
direction of the overall trend, which in this case is down. Because of the quality of the hourly
divergence, it was also able to not only turn the MACD blue line back down, but also to cause a
cross of the 8 and 21 day averages.
After backtesting this kind of entry, I have determined that the divergence on the hourly chart
needs to be clearly defined, which it is in the case of IBM, in order for the subsequent cross of
the averages on the hourly chart to confirm entry. If the divergence on the hourly chart is not of
high quality, it may not have enough power to keep the price moving down.
Breakdown of GS divergence short term swing trade:
Below, you can see the very nice downside divergence on GS. There is great price volatility,
creating multiple V-shaped patterns and the MACD is below the signal line. Now let’s look at
the charts below to see where we could have taken advantage of this opportunity.
Below is a chart of GS daily and hourly charts. Similar to the IBM continuation trade above, the
hourly chart contains a very nice downside divergence, with a subsequent cross of the 8 and 21
hour averages. This divergence plus the cross is the “catalyst” that kicks the price in the
direction of the weekly chart, by turning the daily MACD blue line down and causing a cross of
the 8 and 21 day averages shortly after.
The downward cross on the hourly chart is not significant on its own and does not warrant an
entry point every time. The cross becomes a significant point of entry when it takes place while
a downside divergence of quality is present on the hourly chart as well. This strategy of entry
allows us to capture a much bigger part of the move.
Breakdown of BIDU swing trade:
Below is a double chart of weekly and daily charts for BIDU. There is a very nice upside
divergence, above the signal, on the weekly chart. This is what gives us a potential opportunity.
There is also a very small spread between the 8 and 21 week averages at the time of the
divergence.
The daily chart provides great confirmation of entry for a long term swing trade. The 8 day
average crosses the 21 day average quite strongly, and moves up almost uninterrupted.
Breakdown of CAG swing trade:
Below is a double chart of CAG’s weekly and daily charts. There is a clear downside divergence,
with the blue line right at the signal line, on the weekly chart, which creates our opportunity.
The daily chart gives us a perfect entry point with a downside divergence + a subsequent
crossing of the 8 and 21 day averages. The daily divergence was not necessary but acted as a
strong catalyst to kick the price into motion. This created a much more sustainable move.
Breakdown of GDX short-term swing trade:
GDX had a beautiful trade setup. It started with a perfect V-shaped pattern on the weekly chart,
with the MACD blue line above the signal line. This V-shaped pattern also started stabilizing the
monthly MACD as well, which was very weak. This creates an ideal scenario for an upside trade.
Now let’s move on to the daily and hourly charts below.
Typically, we would wait for the 8 and 21 DAY averages to cross to confirm our entry. However,
as we’ve seen many times, the hourly chart presented us a great opportunity to enter the trade
before that, allowing us to take advantage of more of the move. We are essentially entering the
trade as the daily MACD blue line turns up, like we learned from Dale. The difference now is,
we’re getting a lot more confirmation than just the daily MACD blue line turning up.
On the hourly chart, you can see a series of strong upside divergences + the subsequent cross
of the 8 and 21 hour averages. This acts as a strong catalyst to kick the price into motion and to
KEEP the daily MACD blue line moving up. If there was no divergence on the hourly chart + the
cross, and the daily MACD blue just turned up without an hourly catalyst, the probability of the
price coming back down is much higher because of the weak monthly chart. Without an hourly
divergence present, we would use the crossing of the 8 and 21 on the daily chart in that case,
instead of the hourly chart.
With the hourly divergence present, the cross of the 8 and 21 hour averages is our entry point.
Breakdown of TTS swing trade:
As you can see, TTS had a picture perfect setup on the weekly chart. The price made a perfect
V-shaped double top with an extreme downside divergence on the MACD, well below the signal
line. Once the 8 day moving average crossed below the 21 day moving average, giving us
confirmation of entry for a longer term swing trade, the price just collapsed. Because this
pattern is on the weekly chart and because there was also no clear downside divergence on the
hourly chart to give us earlier entry, longer term options would have been the best way to go.
Breakdown of AET short term swing trade:
Below are the weekly and daily charts for AET. There is some pretty significant downside
pressure bearing on the price, as evidenced by the clearly defined downside divergence on the
weekly chart, that is also below the signal line. This is the setup that gives us an opportunity to
trade. Now we need to look at the lower time frames for confirmation.
Because the daily was still moving up pretty strong as the price reached its previous high,
creating the divergence on the weekly chart, a downside divergence on the hourly would give
us much more confidence in a sustainable move to the downside, as opposed to waiting for the
8 and 21 moving averages on the daily chart to cross. Let’s look at the hourly chart during the
same time the daily MACD turned down to fuel the weekly divergence (classic Dale Wheatley).
As you can see, at the time the daily MACD started turning down, there was a crystal clear
downside divergence on the hourly chart, below the signal line, to kick the price into motion.
This hourly divergence gives us a much more confidence in the trade, especially since the
monthly chart was still pretty strong to the upside. Once the 8 and 21 moving averages crossed
to the downside, our entry was confirmed.
Breakdown of SCCO short term swing trade:
This trade comes from the weekly chart. The price makes a new low while the MACD is
significantly higher, just barely below the signal line. Even better is the upside divergence on
the daily that is above the signal line, which acts as the catalyst to get the price into motion.
Note that when we have a divergence on a lower time frame that kicks the price into motion
like this, the move is much more reliable and sustainable. Because there’s a high quality
divergence on the daily chart, we can now look to the hourly chart for confirmation of entry.
Let’s take a look.
Although you could have used even the 30 minute chart for entry in this case because there is
technically an upside divergence on the hourly chart, it’s a little more broken down, so the
hourly chart is the more conservative entry point. Our entry point was when the 8 hour moving
average crossed the 21 hour average.
Breakdown for MCP short term swing trade:
In this scenario the weekly chart divergence is what gives us our trade but I wanted to add the
monthly chart because this is one of the best scenarios we can have. This is also similar to the
trade breakdowns above on APOL. We have a very strong weekly chart but also a monthly chart
that is pointing up and is above the signal line. In other words, there is no strong resistance
against an upward move, apart from the lower time frames getting in the way. This makes
trading to the upside much easier.
So not only do we have very strong higher time frames, we also have a very well defined upside
divergence above the signal line on the daily chart as displayed below. We even have an upside
divergence on the hourly. Because this is the case, we can keep moving down on the time
frames, making our entry more precise, and also increasing the amount of the move that we
catch.
And what do you know…there’s also an upside divergence on the 30 and 15 minute charts!
Ladies and gentleman, it truly does not get any better than this. I put our entry point at the
cross of the 8 and 21 averages on the 15 minute chart, but because it too had a strong upside
divergence, you could have used the 5 minute chart for entry as well. My only concern with
that would be if you bought options with more than 1 week until expiration because entry on
the 5 minute charts makes you more susceptible to price volatility. But even if you used the 15
minute chart, your entry was still very good. Unfortunately this took place on a stock that
doesn’t move very much. However, the pattern is exactly what we look for.
Breakdown of SPY hourly chart divergence:
This was an excellent trading opportunity for expiration Friday. This is exactly what allows us to
earn hundreds of percent returns. We also had a very low risk reward ratio, where the reward
was so much higher than the potential loss.
We had a beautiful upside divergence on the hourly chart. Price made perfect V-shaped
bottoms with the Macd blue line above the signal line. As you can see, based on where our stop
would be and our target price, the reward for this trade is significantly higher than the risk. Our
entry would have been perfect with using Alexander Elder’s recommendation to enter on the
uptick of the Macd Histogram on the 15 minute chart.
We use the 15 minute chart for entry on this trade because the pattern is on the hourly chart
and we want good entry for a short term trade on expiration day. This resulted in hundreds of
percent returns on the options.
Breakdown of SCCO continuation trade:
This trade was almost a picture perfect continuation trade. Below on the left side of the chart is
the weekly upside divergence that got the price into motion. After the initial price move (phase
1 trade), and the price starts to retrace and take a break, we start looking at the lower time
frames for a reconfirmation of the trend.
In this case, the daily chart MACD blue line is below the signal line, so we need an upside
divergence on the hourly chart to get the price back in motion. You can see on the right side of
the chart where our entry point was, when the MACD Histogram ticked up. Let’s look at the real
reason we entered there by looking at the hourly chart below.
Below, you can see at the time of the daily MACD Histogram uptick, there was a nice upside
divergence on the hourly chart, which is exactly what we needed. While our entry was a little
bit early because the price came back down to retest the bottom one more time, it still ended
up being a good trade. With our stops a little bit below the recent low and a longer term
monthly option (because these are higher time frames we are using), we were perfectly safe to
hold and wait for the move to take place. This was a great trade.
Breakdown of XLE Divergence Trade:
This was a beautiful trade and shows how powerful the divergence trade is. This was also an
excellent setup because there was a divergence trade within a divergence trade.
The main divergence was on the hourly chart. This divergence just on its own would have been
a great trade. You can see the perfect V-shaped double bottom with a MACD divergence above
the signal line. With a setup like this, the probability of the price moving up was so high, that
you could have entered right at the double bottom without waiting for an uptick on the MACDHistogram, with stops $.20 below the bottom.
Another reason we didn’t need an uptick on the MACD-Histogram with this trade is that there
was also a beautiful divergence setup on the 5 minute chart. This gave even more confidence of
a pending move to the upside. It also acted as the ‘catalyst’ to kick the price into motion, and as
you can see, a divergence on a lower time frame within a divergence on a higher time frame
leads to a very powerful move.
First target price is at the previous structure point within the V-shaped pattern on the 5 minute
chart. This creates a very good risk-reward ratio. If you were willing to take a little more risk,
you could have held the position until a 1 minute downside divergence was formed and just
moved your stops up to the break even point.