This type of oscillator revolves around using two moving averages and plotting the divergence between them. To understand these oscillators, a small detour to look at moving averages is appropriate.

A moving average is calculated by averaging the closing price over the previous x periods. For example, a simple moving average of closing price over eight days is the sum of the closing price of those last eight days divided by eight. So, to get one point on an eight-day moving average, you need eight data points. A simple moving average is shown in the below figure.

A single moving average is of limited use. All it comprises is a lagging average of what has gone on before. Lagging means the price action itself will have changed direction before the moving average. In some instances, a moving average performs a similar function to a trendline on a chart in that it will act as a line of support in upward moves and a line of resistance in downward moves. As such, the crossing of a single moving average can signal a change in trend. There is much more that can be done with moving averages, though.

When you combine two moving averages, you get clearer signals. Essentially, you pick a shortterm moving average and a long-term moving average and take your trading signals from when they cross each other. The two most significant patterns formed by the crossing of two moving averages are the golden cross and the dead cross.

Scalping trading technique accounts some secondary and somewhat lower probability patterns. These trading patterns must be paired with other analysis tools, such as momentum from the market maker screen. In this case they may be traded successfully.

The „FLASHBACK“ is another morning trade pattern based on a quick reversal. Of course this reversal is done in the direction of a stock's price. In this particular case it quickly fakes one direction, then reverses back the other way to break the current high or low of the day. Just look for the market index to be moving in the same direction the trade is taken for it to be worthwhile. The below picture shows how it sets up for a buy trade:

This pattern could be considered if the overall market index begins moving up significantly and there is enough distance to the high from the breakout to make a valuable profit. In order for the trade to generate money there should be atteast 1 + points from the breakout point to the high of the day. These trades can be good on a day when the market runs down in the morning and then makes a smooth, rounding bottom that subsequently swings back up.

These examples are often strong trade setups that may be taken for a reasonable percentage of success. The most important thing here is to get in early on a strong move that will allow quick and decent scalping profit.

The concepts of support and resistance are essential when selecting entry and exit points for trading a trend. These are not esoteric theoretical concepts for notions based in voodoo or some other mystical realm. They are reflections of the repetitive nature of market participation. First of all, let us talk about a resistance level in an uptrend, as illustrated in the below figure.

At point A, traders operating without knowledge of when best to enter a trend buy in. Instead of receiving a price appreciation, however, they see the price fall after their purchase. Feeling sore, they look for an exit that limits the damage to their capital. That point comes at B, when they can get out even, which most people will settle for when they have a negative perception of the position they hold. This then causes a wave of selling when those that purchased at point A decide to get out. This cycle can go on and on. If there are sellers at the resistance level, it probably means that there were members of the public buying at that level and the cycle can repeat.

The obvious question is why the buyers at point A did not cause a further price appreciation? The reason is that trends always move in a zig-zag formation, and there were more eager sellers than willing buyers in the public at that time. As a technical analyst, you don't care why this happens, you merely note the effect and try to profit from it. Support occurs when the price action takes a security down to a level where there are willing buyers in the public. This can happen for various reasons. Buyers may come in to cover short positions that did not work out as intended and seek to get out even, just as long holders did in the uptrend discussed previously. It can also be that for whatever reason, the stock is perceived as cheap once it has reached that level. Again, there can be many reasons, and we are only interested in trading the effect, as and when it happens.

Another important effect to be aware of is that support becomes resistance if that support level is broken. Consider the below figure.

In this figure, we see the usual downward zig-zag formation of an established downtrend. At point A, we can imagine some traders thinking that the security has gone as low as it should and that the trend is reversing (these are clearly not disciplined technical analysts), and they buy the security. The security rallies briefly, but the strength of the trend carries it lower and these traders find themselves in a losing position. When the security rallies briefly, the traders look to get out even, so as soon as the price reaches their initial entry point, they exit in a wave of selling, pushing the security down further.

Support and resistance levels can arise from many other causes. The trendline itself is important as a support or resistance indicator. The greater the number of times the price action has bounced off a trendline, the more significant a break of that trendline becomes. What this means in terms of concrete action taken by day traders is that if you have a position in a security that has seen more than six bounces off a defined trendline, any break of that trendline should immediately trigger liquidation of that position. The breach of a long-established trendline tends to be followed by a rapid move in the opposite direction of the recent trend. In addition, round numbers can become significant levels in a stock's price action. Under certain market conditions, the fact that there are lots of bids at a certain level can create support; conversely, a lot of stock offered at a certain ask price can create resistance. This is by no means the whole story, as we will see in Chapter 4. Round numbers as support or resistance certainly ranks as a secondary effect. Day traders should be aware of it, but not driven to action by it.

These levels of support or resistance are used to time entry and exit points in trends. We have already discussed the correct place to enter a trend: on a pullback to resistance. Should the expected bounce in the price action not take place immediately, however, at what stage should traders close their losses? That question has no definitive answer; it depends on many factors at the time of the trade. The main concern is that we believe the trend to have been broken by the unexpected move. When we are convinced of the break, the time is right to cut our losses. When entering the trade, it is wise to have a level in mind that will trigger you to cut your losses. If that number is reached, you will invariably do best by exiting immediately.

When we are in a trend and see it weakening, there is also a decision to make as to when to lock in profits. During Phase 1 trading, if I have a long position, I usually exit a position at the first sign of a slowdown in the buying of that security. During Phase 2 trading, however, if I have correctly bought into a trend and see immediate price appreciation, I allow the trend to mature and test the trendline on pullbacks in anticipation of further gains. In general, I do not let the price drop more than a 1/4 past where I perceive the trendline to be without closing my position in these circumstances.

The very first trade is an intraday pattern of a 5 minute bar chart that is called „dip and rally“ setup for a buy breakout.

The consolidation at the high of the day is considered to be the key to the success of this setup. This is also true for other pattern variations. This is very good if the consolidation is very long and tight. This is a setup that can be developed all trrading day long.

There is also another pattern, that is more obvious. It looks like this:

Another intraday consolidation pattern that you can see on the below illustration looks a little different. It can be a powerful setup:

In the setup #3 depicted above, an active stock can show a tremendously illiquid intraday bar chart. The most important for this chart pattern is to make sure the stock averages good volume on a daily-basis (for example, 100k shares +), and that the daily bar chart shows good space tor movement to the upside with nearby price resistance. You can also keep tabs on its volume in the market maker screen.

The next chart is another well known example that leads to consolidation and a wonderful breakout trade:

Early morning consolidation (similar to pattern #2) can be an important part of entering trades at the start of the trading day (remember though that it is best to wait about 10 minutes before you enter a trade). This way you can catch the first and best breakout. If you are following a particular stock with the expectation of a good move on the day (or simply stumble across one with the following pattern), it may be considered a strong trade candidate. This is especially true if your market maker screen is moving and showing momentum coming into the breakout. The pattern consists of just a few bars on the morning and a range of only a 1/8 to 1/4.

The point in this pattern is to catch the earliest breakout and the best price. Of it was not possible, then pass up the trade. You should never chase a stock.

Once a breakout takes place, the stock normally spikes out of the consolidation to begin a strong move. If you miss the initial breakout, other consolidation opportunities may setup in the stock as the day progresses. For example:

There is no doubt the first breakout is the best one to take. The question arises though, whether you should take the second, third, fourth, etc… breakout. If you missed the earlier breakout(s), how do you know whether or not to take the next one? The best way is to know how long the overall market has been moving in a direction, and if it is losing steam. Also, consider the average daily range of the stock as welt as the strength (momentum) coming into the breakout. If the stock often trades a two to three point daily range, then the subsequent breakouts may still have scalping potential if the range on the day is, for example, only 1 and 1 /8 points at that time. Simple looking at the daily historical chart will show whether the price is breaking out of a daily consolidation area and if daily support or resistance has been broken. This can often lead to a large magnitude move and a stronger initial price Spike, even if the last few daily bars have been in a narrow price range. Again, the longer the consolidation on the 5 minute bar chart, the better the trade.

Trade setup #7 depicts two good trade entry points following extended consolidation. Consider both of them. The second breakout to the downside could also be traded.

„Wedging“ consolidation on the 5 minute chart, especially if it develops over the first 1 to 2 hours of trading, can precipitate strong breakout moves. This pattern usually sets up for a trade on the long side Consolidation at the high of the day must be present and hugging the upper price boundary as the wedge pattern unfolds. Here is the buy setup:

The flag formation is characterized by narrow oscillations contained within two bands that form a channel. Typically, the channel is either in the direction of the trend or against it. The pattern has a higher degree of predictive capability if the channel is in the opposite direction to the main trend. These two options are illustrated in the below figures.

The pattern is complete upon the break of the upper line that marks the boundary of the channel. The number of oscillations in the flag is not important. That will vary depending on the time horizon of the chart you are using. I traded a continuation pattern recently that looked quite different on a one-minute chart from how it appeared on a five-minute chart, both of which are shown in the below figures.

In this instance, the stock had fallen in premarket activity on weak bad news and staged a strong recovery in the Phase 1 market period. As no trends have been formed this early in the market, any trades that I enter are usually either the result of the first move in the opposite direction of the premarket gap, or of continuation patterns if I miss the first move. In this case, I missed the first move against the gap and took a long position as close to the entry point as I could get. In this situation the trade worked out well, and I exited the position when the upward move positioned the flag at halfway in the trend. Typically, a consolidation flag will appear halfway within a move, which has led to the expression: „Technical flags fly at half mast.“ What actually happened in this case was that the stock moved appreciably higher than the point at which I exited. On a technical basis, however, holding the position beyond what was predicted by the continuation pattern would have moved me into the hope and away from the reality column. Over time, that most likely will lead to diminished returns.