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6,362 posts
msg #42708
Ignore TheRumpledOne
4/2/2006 10:29:45 AM

Time Frame Divergences Perspectives for the week ending April 1, 2006

Our society has taught us to bargain hunt. The success of Walmart, Costco and the infinite number of dollar stores is due to consumers' desire to find a good deal. Many investors transfer that thinking to the stock market where it often fails to make them money. To make money from stocks that are showing weakness we need to understand the concept of time frame divergence.

There were many people seeking bargains by buying stocks that seemed to be on sale after the technology bubble burst in the first quarter of 2001. A stock that had been trading at $125 a share seemed like a great deal at $60, after all, it was less than half price. Unfortunately, most technology stocks continued to fall to much lower levels and five years later these stocks are still nowhere near what they once were. Buying stocks on sale was akin to paying for a nightmare.

To be simple, buying a stock that has shown recent weakness is only a good buy if that stock is likely to go higher. To determine that potential, traders should look for different messages from charts in different time frames.

A day trader typically looks at 2 or 5 minute intraday charts to determine entry and exit points. However, it is better to look at multiple time frames and use divergences between the short and long term time frames as an opportunity for entry. Consider a daily chart that is showing a breakout from an ascending triangle pattern, but the intraday chart has a downward trending flag pattern. The trader who looks only at the intraday chart would say sell. The day trader looking at both the daily and the intraday chart would be looking for an opportunity to buy the bounce.

This methodology can be used for any style of trader. Weakness in a daily chart is an opportunity for the long term position trader if the weekly chart is strong. A daily chart upward trend should encourage us to look for pull back opportunities on a 15 minute intraday chart.

There are a wide variety of traders participating in the stock market. Most of them focus on their outlook without consideration of what others may be thinking. They get caught up in the charts they are looking at and can lose sight of the big picture. Traders should always keep in mind that the longer term time frame is always more important than the short term.

Opportunities can be found when the short term chart time frame diverges from the long term. If the weekly daily and 15 minute charts say the stock is going higher but the two minute is headed lower, chances are good that day traders are getting shaken out of the stock and being taken advantage of by the longer term traders and investors.

I like to look for inflection signals in the short term time frame when it diverges from the longer term. If the long term outlook is higher and the short term is showing weakness, I will look for a break of the short term negative pattern as an entry signal.

In doing so, you are taking advantage of the emotional reactions of one group of market participants that conflict with the long term market outlook for a stock. Opportunities are created when market participants act emotionally.

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