1. RSI + MACD Divergence
The RSI (Relative Strength Index) and MACD (Moving Average Convergence Divergence) are two common indicators featured in many day trading guides, known for their ability to help traders identify price changes in fast-moving markets. Both the RSI and MACD are used to gauge the momentum of a trend, but when they diverge from the actual price movement, it's often an early warning sign that a reversal may be due soon.
Entry/Exit Criteria
Entry:
- Divergence in RSI and MACD: For a bullish divergence, the price makes a lower low while the RSI and MACD make higher lows. Conversely, for a bearish divergence, the price makes a higher high while the RSI and MACD make lower highs.
- RSI movement: An entry signal is given when the RSI crosses above 30 (indicative of potential upward momentum) or dips below 70 (suggesting possible downward momentum).
Stop Losses:
- For a bullish divergence: Traders will often place a stop loss slightly below the recent swing low or a support level.
- For a bearish divergence: It's typical to set the stop loss just above the recent swing high or a resistance level.
Take Profits:
- Traders may consider closing their position when there's a shift in the momentum indicated by either the RSI moving back to the 50 level or the MACD line crossing its signal line.
Why Does This Strategy Work?
When both RSI and MACD show divergence with the price, it's like having two witnesses corroborating the same story. Divergence in these indicators often suggests that the prevailing momentum behind a price trend is weakening. This weakening momentum, coupled with other market factors, can lead to a trend reversal.
By entering a trade when the RSI dips below 70 or rises above 30, traders are attempting to catch the initial phase of a potential trend reversal, capitalising on the early momentum shift. The combined strength and validation from both indicators provide a more robust trading signal, reducing the likelihood of false entries and improving the probability of successful trades.
A Pullback to Support/Resistance
Understanding support and resistance levels is fundamental in technical analysis. These levels represent price points where the asset has historically faced buying or selling pressure, making them pivotal areas to watch.
When the price breaks through these levels and then retraces to test them, traders have an opportunity to capitalise on the market's attempt to reconfirm or challenge the breakout. This price action strategy is preferred by many for its simplicity and repeatability.
Entry/Exit Criteria
Entry:
- After a bullish breakout: The price should retrace back to what was previously a resistance level. If this resistance-turned-support holds, it's an indication that the breakout is genuine and the price is likely to continue its upward trajectory.
- After a bearish breakout: The price should retrace to the former support level. If this support-turned-resistance holds, it suggests the breakout is valid, and the price may continue its decline.
Stop Losses:
- Following a bullish breakout: Traders often position the stop loss just below the new support level (formerly resistance) or an adjacent swing low to safeguard against false breakouts.
- After a bearish breakout: The stop loss is typically set just above the new resistance level (formerly support) or a nearby swing high.
Take Profits:
- As the price progresses away from the support or resistance level post-pullback, traders could eye subsequent support or resistance levels as potential areas to take profits.
Why Does This Strategy Work?
A pullback to support or resistance is essentially the market's way of reevaluating and confirming its initial breakout decision. If resistance is broken and then successfully tested as a new support, it underscores the market's bullish sentiment. Similarly, if a support level is breached and then reaffirmed as resistance, it underlines the bearish stance of the market.
This self-confirmation builds trust in the breakout's authenticity, allowing traders to join the trend with more confidence. As this dynamic unfolds, it attracts more participants, further fueling the trend's direction.
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