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Rookie Corner: The Momentum Tools II

November 7, 2019

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Hey Bloggers! How about those markets? Reaching new highs and just chugging along. WOW! These markets are definitely tying into this blog topic in a big way. Last week we talked about the RSI indicator and how it functions. We discussed both its ability to show overbought and oversold conditions as well as its ability to signal a condition called divergence. Divergence is essentially the picture of slowing momentum. When we see indicators and equities or indexes going in opposite directions then we call it divergence and this “CAN” signal that a change is on the horizon.

You may notice that I capitalized the word “CAN” and I did so for a very good reason. As discussed in the blog last week I spoke the gospel of how indicators are not reliable trading signals and that they are just merely confirmation for what we already know or believe by looking at the price movement of the stock. The market has presented me with a unique visual of this in action. You see until the S&P 500 broke out above resistance about 5 days ago I was seeing some divergence in the indicators that made me cautious about this latest run but as you can see from the charts below that divergence of indicators is not a guarantee of anything but more just another piece of a puzzle that we must put together as traders.

If you look at the two charts above you will see that I marked the pivots in blue circles, you will notice that the circles in the price chart are higher than those in the indicator charts at the bottom. This is the divergence that I was speaking about earlier. This divergence was noticeable on or around the 19th of September when the indicators made another pivot that was lower than the preceding. This was the time to take notice of the divergence but not the time to act on this information as evidenced by the price action going forward. You see the index chose to chop sideways for a while before taking a short-lived dip and then proceeding to all-time new highs. Despite the dip in the index the pattern never really changed from a macro view, the pivots on the index were going higher and the pivots on the indicators were going lower but what happened or didn’t happen next is of the utmost of importance, the price action didn’t give us a reason to get short. After the last pivot in the index, the resistance was tested and broken and then the markets were off to the races. This is the clearest example that I can think of as to why we need something other than indicators to tell us when to trade.

This brings to the second indicator from above, the MACD. I must admit I like the RSI and MACD indicators because I am a bit of a contrarian by nature and if anything can give me a heads up that change might be coming I get kind of excited for the opportunity to jump onto the other side of the trend, however as I have shown here that is proper patience is not exercised then one could be jumping in front of a freight train and it ultimately affects the bankroll.

The MACD is a momentum indicator that can generate buy and sell signals as well as give us a clue about slowing momentum or divergence as we discussed above. The MACD is basically the difference between two moving averages that are plotted on a line. The two moving averages are the 12 and the 26 EMA, exponential moving averages. One is slow and one if fast and that contrast is what gives us a view of the momentum. This MACD signal is plotted against the 9 EMA and when the signal line crosses above the 9 EMA then that generates a buy signal and when it crosses below the 9 EMA it generates a sell signal. I don’t personally use the MACD this way because I find that it lags the price action too much and I can get a buy or sell signal from the price action much earlier. I do like the divergence action of the indicator for all the reasons I stated earlier but this must be done with caution.

I think you can see how these two indicators can be useful, try throwing them on some charts to see how they can fit into your trading plan or style, just remember to heed the warnings.

Next week, I will talk about my favorite intraday trading indicator and then I will throw a video together using the indicators so that we can see them in action!

Trade well All,

Coach Holmes

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