Looking for divergence between price movement and oscillator peaks and valleys is a fairly standard strategy for identifying buy and sell signals in the market. The snap shot below is an ES 06-09 Emini 310 tick chart taken at about 1 PM on March 13th, 2009. The oscillator in the bottom panel is the standard CCI(14) indicator. The other lines on the chart are just some moving averages used to help determine the direction of the current trend.
My approach is to look for peaks and valleys in the CCI that occur above or below the 100 line. Divergence is achieved when a line draw between the peaks (or valleys) slopes in the opposite direction of a corresponding line draw from the highs (or lows) of the price bars. Once divergence is found the entry would be at the point where the CCI turns and cross the 100 line. The exit would be either a predetermined profit target/stop loss or a trailing stop based on the something like the "3 Bar Reversal" technique.
In example 1 you will see that the CCI valleys form an up trending line while the price bars directly above the two valleys form a down trend. This set up for a buy signal would be confirmed when the CCI turns up and crosses the 100 line. Of course the converse would be true for a sell signal setup.
In example 2 you will notice that the two CCI peaks form a horizontal line with no slope. This is also a type of divergence when the corresponding price bars trend up. This would be a set up for a sell signal. You will notice that in this example I skipped a small peak in the CCI. Doing this actually makes for a stronger signal. Like example 1, the converse would be true for a buy signal.
To summarize... when divergence occurs in the valleys of the CCI then I look for a buy signal. When it occurs on the peaks of the CCI then I look for a sell signal. In the case where the peaks form a horizontal line then I look for a sell signals if the price highs trend up and if the valleys form a horizontal line then I look for buy signals if the price lows trend down. Since this trade is looking for a reversal in price I make sure that the setup is occurring on the correct side of the trend lines before considering it.
Of course, like most trading set ups, the greater the volatility going into the set up the more like the outcome will be profitable. You will find that this strategy works the same on futures, forex and stocks.
Trading Futures contains risk of loss and is not for all investors.
The information on this site is meant for educational purposes only.
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