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Support Tests, Money Flow Divergences, and Scalp Profits

08/17/09 09:19:49 AM
by Donald W. Pendergast, Jr.

Executing trade entries near strong, well-defined support and resistance areas can be an effective trading strategy, particularly when combined with momentum and money flow divergence analysis.

Security:   ESU9, .SPX, SPY
Position:   N/A

The Standard & Poor's 500 has begun to enter a period of sideways or consolidating price action, duration unknown. While that might be of concern to longer-term investors and traders, for daytraders, it couldn't matter less which way the market is lurching on a daily, weekly, or monthly basis. Here's a brief look at the essential decision-making processes that went into an intraday scalp trade in the S&P 500 emini futures contract, one that yielded 1.75 points in about 12 minutes. See Figure 1.

FIGURE 1: ESU9, THREE-MINUTE. Strong support/resistance levels can help identify likely areas to initiate trades, particularly when substantial price-momentum and price-divergence imbalances are evident.
Graphic provided by: Interactive Brokers TWS 3-minute chart.
After the broad markets made a fresh swing high on August 12, 2009, they began to enter a period on consolidation; this is perfectly normal market behavior, as it allows time for the market to return to a point of equilibrium before (hopefully) moving higher again.

As prices plunged on the three-minute chart on August 14 (falling by 17 points in less than 45 minutes), intraday traders began to focus on one of their key trading tools, the floor trader pivot calculations, also known as pivot points. The pivot price levels are determined by a simple range calculation derived from the high, low, and close of the prior day's price range in the S&P 500. Some feel that this method is too simplistic to provide a real trading edge in today's world of highly complex neural network and genetic algorithmic trading systems, but my own trading experiences have shown that such basic tools can be extremely effective when combined with other technical measures.

Be that as it may, by early morning, prices had begun to respect the pivot level S1 (the red line S1 is support level 1) at 993.00, and in fact, was only mildly breached on one occasion at 8:33 Pacific time. Meanwhile, the volatility of the price bars on the three-minute chart was easing up even as the momentum (9) and Chaikin money flow (21) indicators also made swing lows right around 8:30. This began to catch my attention, so I began to carefully monitor the chart, looking for a possible buy setup to manifest.

Prices continued to stabilize even as the volatility shrank to minuscule levels. All the while, the CMF and momentum indicators were gradually rising in stark contrast to the sideways price action on the chart. So I had ample confirmation that money was flowing into this market (on the three-minute time frame) and that momentum was gradually rising as well. Even better, S1 had proved itself to be an admirably strong level of support.

My next task was to locate a suitable entry trigger, and I found it soon enough; the flattening 20-period EMA (blue line on Figure 1) was reading about 993.50, so I placed a buy-stop just above it at 993.75 and waited a few minutes. The fill came in at 993.75 at 9:36. I placed a mental stop at 992.50 and let the trade develop. I exited on a limit order I'd set for 995.50 about 12 minutes later; I noticed that the NYSE internals had strengthened since entry, so I decided to go for 1.75 points instead of my usual one-point target on a three- minute chart. The rock-solid support of S1 also figured into my decision to go for a slightly larger gain. The drawdown on the trade was modest, a mere 0.75 of a point, and I was very satisfied with the return on the trade.

FIGURE 2: NYSE INTERNALS. Although the NYSE internals were bearish at the time of trade entry, they had improved substantially from their morning lows. Such readings did not necessarily militate against a long scalp trade entry at 9:36 Pacific time.
Graphic provided by: Interactive Brokers Market Statistics screen.
You'll note how ugly the NYSE tape was at the time of trade entry, perhaps causing some traders to question my sanity in regard to placing a long trade in the face of such negative market internals, but we need to put things into context. First, those readings are cumulative totals and already include the dramatic intraday selloff that took place some two to three hours before trade entry. Second, the internals were already beginning to recover at the time of trade entry. Finally, realizing that the art (yes, it is an art, and not a science) of discretionary trading involves factors that no computer or trading algorithm can ever begin to quantify (the human, gut-level intuition that results after having analyzed tens of thousands of charts for many decades), I had a feeling of total serenity as I put the trade on at 993.75.

Of course, this feeling of peace was the by-product of having made many trades just like this one, trades that usually win 75% to 80% of the time. The only tools needed were the floor traders pivots, a nine-period momentum indicator, a 21-period Chaikin money flow indicator, a 20- and 50-period exponential moving average (EMA) and a way to access the NYSE internals, easily acquired from my Interactive Brokers Trader's Workstation (TWS). That's it: no systems, no red- light, green -light lunacy, no neural gimcrackery, and, best of all, no reliance on "instant alerts" from "emini headquarters." In other words, a low-cost, fully developed homemade discretionary emini trading methodology that works. See Figure 2.

Try it yourself. Set up a three-, five-, eight-, or even 10-minute intraday chart with the same indicators shown, making sure you have access to real-time NYSE TRIN, tick, advance/decline, and up volume/down volume data. Then practice for six to 12 months using a live trading simulator or paper trade account. Do that and see how much profit you can generate, being sure to adequately record your vital trading stats in Excel or Open Office spreadsheets. If you do this faithfully, you may be surprised at how quickly you can learn to successfully read the markets. Practice makes perfect, and you'll be well-served by putting in the hours of practice now, long before you attempt to enter the bizarre and exciting world of intraday stock index futures trading.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title: Writer, market consultant
Company: Linear Trading Systems LLC
Jacksonville, FL 32217
Phone # for sales: 904-239-9564
E-mail address:

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Date: 08/17/09Rank: 5Comment: 

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