Bullish Convergence Pattern

Bullish Convergence Pattern

In Chapter 4, we went over how the market price makes lower lows, but not by significant measures, and that when prices are at oversold extremes, we should be cautious for market reversals. We went over the market condition of bullish convergence and how to use the stochastics and MACD indicators to confirm buy signals when that market condition exists. The jackhammer is a formation that seems to be present in such a situation. Therefore, it is a great method for setting up a potential buy signal once the pattern is confirmed.

Look at Figure 8.34, e-mini-S&P 500 futures. As you see, the midsession of the trading day at 12:30 shows on the charts that the market takes a secondary decline, forming that spike bottom hammer pattern. Notice that the very next candle after the hammer is a tall engulfing candle that forms a higher high. Prices then continue on in the sequence of higher highs, higher lows, and higher closing highs, while continuously trading above the moving averages. If you examine the stochastics at the bottom of the chart, notice that when the price made a new lower low, the reading from the stochastics made a higher low, identifying that bullish convergence existed. If you watched for the stochastics to close back above the 20 percent line to confirm the price reversal and the trigger to go long, you would have had a stress-free trade that resulted in immediate returns.

In Figure 8.35, you see another example of the e-mini-S&P, this time with the aid of the MACD study. The jackhammer occurs past the midsession and actually closer to the close of business. Here we see both the moving average and the histogram components alerting us to the fact that the price action was oversold and that a reversal was likely. The one-two combination of the jackhammer and then the bullish engulfing pattern revealed a forthcoming price reversal.

Stocks Get Jacked, Too

The psychological aspect of this formation occurs in stocks as well. Believe me, they are not immune to the ravages of human emotion. The example in Figure 8.36 is Comcast Corporation and is a great illustration of how the stochastics indicator confirms that the jackhammer, or secondary low buy signal, was triggered as confirmed with a bullish convergence signal. The fast stochastics indicator shows the timing of both %K and %D closed back above the 20 percent line, confirming a bottom was in place. The trigger to go long here is on the close of the hammer at 26.63; and before the close at 4 p.m. (ET), the market price is at 26.84.

The Jackhammer’s One-Two Punch

Figure 8.37 shows a 30-minute chart on United Technologies that illustrates, depending on the time period, that the jackhammer pattern can exist from one day to the next, like a one-two knockout punch that attacks the stops and immediately pops up.

Since many traders look at the obvious low point to place their stop-loss order, as this example shows, the jackhammer took out the prior day’s low; and then once again, the one-two pattern develops with the hammer and then the next candle being the tall white, or bullish, engulfing candle. This starts the immediate price reversal, with the sequence of higher highs, higher lows, and higher closing highs. See how the market also closes above and continuously trades above both the moving average values.

If you know what to look for, trading for a living is a great opportunity; but with opportunity comes responsibility. Prior to entering a trade, you should have your “pregame” setup, complete with your market analysis and rules for entering a trade. Certain rules should start with the techniques covered in this book so far, which include:

• Identifying what the market condition is—overbought or oversold bullish, bearish, or neutral.
• Identifying the levels that the pivot points lines are at, using the various time frames—monthly, weekly, and daily periods.
• Setting up your charting software parameters with these specific pivot points moving average values.
• Experimenting with variation settings on your own.

Then you need to watch and identify when and at what price points the dojis, hammers, and shooting stars develop. Knowledge of these items will arm you with critical information that can help provide protection from overtrading as well as from adverse moves and such pitfalls as reacting on emotions rather than on actual trading signals.

SUMMARY       

The method of market analysis described in this book is designed so you will be educated on the importance of developing your personal trading system and so you can apply the techniques on a consistent basis, which will allow you to make decisions in a mechanical and non-emotional way. Common mistakes that traders make are not testing a strategy and not making a logical determination of whether the strategy is viable for their trading style. Many traders adopt a new strategy, trade with it, and immediately start tweaking different components of the strategy. The best approach that I have found in trading is to establish trading rules and to test those rules until an outcome is determined based on a reasonable number of trades. Also, I have several different trading strategies for different markets or conditions. The high close doji, the low close doji, and the jackhammer patterns are just a few of my proprietary setups that I watch for meeting these conditions.

If you are in a declining market, once an apparent bottom occurs near a pivot point support target, watch for the high close doji or the jack hammer pattern to develop. In a rising trend, once the market trades at or near a projected pivot point resistance, watch for a low close doji or a shooting star pattern. These specific patterns can be added to your personal toolbox of setups or used exclusively as a day trading plan. By understanding the current market conditions (uptrend, downtrend, or sideways), you can heighten your awareness of specific patterns that can be applied to that trading environment. All that is left after entering a position is risk and trade management, which is the focus of the next chapter.