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the interpretation and application of price action concepts

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Over/Under Divergence Setup


Thanks to Birdman for the explanation. Visit his site for more trading tips and charts.  


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Over/Under Divergence by Birdman

      Over/Under Divergence is a very good way to find tops and bottoms in the market. Below you will see how to find these divergences on all charts, all timeframes. With dedicated screen-time, it's possible to train the eye to catch this setup over and over again. The next step, then, becomes learning to apply it at the right times. Only experience can teach this, but here is a great place to start.

 

Over/Under Divergence - an attempt to predict a market TOP

1. The Indicators -

     A. The only indicators used on this setup will be the 7, 3, 3 stochastic and the 21, 10, 4 stochastic. The respective settings for these can be found on the Chart Template section.

 

2. The Pattern -

     A. The market tests the previous swing high.  This can turn into a 2b setup as well.

     B. The 7,3,3 stochastic must be making a LOWER high than on the previous market swing.

     C. The 7,3,3 stochastic must be BELOW the 21,10,4 stochastic on the current market swing but ABOVE it on the previous market swing.

     D. Once the test or 2b poke bar occurs, the next bar must take out the LOW of the poke bar.  This will cause the 7,3,3 stochastic to fall with it.

 

This is where the name "Over/Under" comes from. Think of it as nothing more than the stochastic being OVER the 21,10,4 and then UNDER it, when comparing the two swings. This gives a way to easily quantify what may be market that is losing it's strength. Once the market takes out the low of the test bar (or 2b), the setup is complete and may be a place to exit any long positions, and in many situations it can be a place to enter short. Usually, the 21,10,4 will also be pulled down by price.

 

Under/Over Divergence - an attempt to predict a market BOTTOM

1. The Indicators -

     A. The only indicators used on this setup will be the 7, 3, 3 stochastic and the 21, 10, 4 stochastic. The respective settings for these can be found on the Chart Template section.

 

2. The Pattern -

     A. The market tests the previous swing low.  This can turn into a 2b setup as well.

     B. The 7,3,3 stochastic must be making a HIGHER low than on the previous market swing.

     C. The 7,3,3 stochastic must be ABOVE the 21,10,4 stochastic on the current market swing but BELOW it on the previous market swing.

     D. Once the test or 2b poke bar occurs, the next bar must take out the HIGH of the poke bar.  This will cause the 7,3,3 stochastic to rise with it.

 

Like the Over/Under Divergence setup, the Under/Over is doing nothing more than trying to find a weak market that may be running out of juice. It will take screen-time to learn when to apply these setups. Here are a couple of hints:

1. If the setup occurs in tandem with another setup you have trained your eye to see, the likelihood of success is higher.

2. Key points on Trendlines, Moving Averages, and Bollinger Bands may offer a particular spot to look for the setup. Primarily, if price is trading at one of these noticeable points, it may be beneficial to look at a smaller time frame for the setup to appear, giving you a better entry.

3. In a strong trend, beware. What may appear as an Over/Under setup could be nothing more than a pullback on the higher time frames, which often doesn't give enough room to trade. A couple warnings may be a very strong stochastic that has been above 80 or below 20 for a long time. This signals a trending market. A large spread in MA's may often warn of a strong trend as well. Like anything else in trading, there are many other ways to avoid the cautious areas.

4. Naturally, if the higher timeframes support the direction of the divergence, it has a higher chance of success and also often has more room to run. It would probably be smart in the beginning to take only these divergence trades with the trend of the higher timeframe.

Traded properly, this setup can be very profitable with high rates of consistency. At the same time, it often provides an entry with extremely low risk compared to the potential reward. Learn to train your eye for the appropriate places to apply the setup, and you will be greatly awarded!


 

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