Working with price extremes.

Discussion in 'Technical Analysis' started by alex.samant, Nov 16, 2007.

  1. Hello everyone,

    Everyone is saying that picking tops and bottoms is a self-defeating approach and this and that. Ok. I admit, picking tops and bottoms per se, is not the beginners bread and butter, but, for a trader that knows his risk and is also an advanced technician, there are ways and means...

    First of all, when you pick a top or a bottom, you have to always make sure that a higher timeframe trend is in the direction of your trade. For instance, if you want to buy a double bottom, you first have to make sure that the higher timeframe trend is up. If you want to sell a bearish divergence, again, make sure the higher timeframe trend is down.

    The second thing is, HOW do you approach the PRICE EXTREMES you want to buy or sell.

    Thank god, today we have all these computers and formulas already invented (we have no clue how to use them though).

    Today I want to talk about the Stochastics oscillator, which is considered to be one of the most accurate oscillators out there.
    I agree. But, It's not the oscillator that's doing the job. It's the market.

    You have to consider that all the oscillators/studies we have are conceived in an ideal market condition, where volatility and capital flow are constant.

    However, the market is not like that. The market is manic and it can be active now and totally dull three hours from now, therefore making the oscillator relevant now and totally irellevant in the near future.

    I will issue an example of a failed bearish stochastics divergence, that occurs maybe more than 50% of the time and kicks trades in the head. I will discuss it below.

    [​IMG]

    In the image above, we were in a downtrend (still) and there we had this nice divergence, right? Right. BUT, you can see the market volatility being different at the left side of the chart, at the middle and at the right edge.

    The truth is, the first peak was not a PRICE EXTREME.

    What is a PRICE EXTREME? You can define it however you want, but i like to peg it to volatility, so then I use Bollinger Bands.

    I like to call price as being EXTREME when it trades above the 2 standard deviation 20 MA Bollinger Band. (closing basis) or below the -2 standard deviation 20 MA Bollinger Band.

    Now, knowing what is an EXTREME, you can now compare the EXTREMES by looking at the ratings of the Stochastics oscillator.

    Another divergence, this time between 2 price extremes, that actually worked.

    [​IMG]

    Note: The images do not have bollinger bands plotted. The bars are orange and red when price is trading below the BB (20,-2) and blue and cyan when price is trading above the BB (20,2).