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Trading is searching for high-probability opportunities, as, regardless of your holding

period, you are always striving to gain an edge. I have found that convergence of
indicators such as support, resistance, trend lines, moving averages, Fibonacci levels
and volatility bands also give you an edge and chance for a high-probability entry.
You can be very successful by buying pullbacks in uptrends (the reverse is true for
sellers) when they coincide with convergence.
This lesson will demonstrate the interaction of convergences from an intermediate
period
on the daily chart with the one-day volatility bands. (To better understand the lesson,
you should first read my article, Short-Term Volatility Trading Bands, in the Trading
Strategy section on the site.)
As I have mentioned in my previous commentary, in order to maximize use of this
strategy, you should always have your key stocks or indexes framed in advance so that
you may take advantage of any air pockets that occur which might give you good entry.
On the Jan. 20 daily chart of General Electric I have framed the key reference points
1. X1 is a significant bottom in October 1999 at 114.625.
X2 is a significant top on Dec. 27, 1999, at 159.50.
X1A is a minor bottom at 130.
2. After you have marked the significant top and bottom, you can
calculate the Fibonacci retracement levels between 114.625
and
159.50.
The levels are as follows:
.38
142.44
.50
137.06
.618
131.76
.786
124.22

3. Draw your key trend lines. See TL 1 and TL 2.
4. Identify the key EMAs on the daily chart. Most software
packages
have the ability to interface the EMAs of your choice and also
enable you to get your Fibonacci retracement levels. The key
exponential moving averages (EMAs) are as follows:
50-day EMA 144.48
200-day EMA 124.85
The EMAs and the Fibonacci RT levels are located bottom
right on the
chart.
5. Identify support or resistance levels. In this example, I have
marked the following support levels that come into play:
S3
142.56
S2
130.00
If S1 was penetrated, we would be looking to short so it doesnt come into play for this
example except as the initial point to draw the intermediate TL 1.
Please note that the S3 level pf 142.56 was made just above the 50-day EMA which
was 141.84 on Jan. 5, the day S3 level was confirmed. As you can see on the chart, the
50-day EMA also acted as support at the S1 and S2 levels. You should also observe
that these pullbacks all consisted of 3, 5, 8 or 7 day retracements after swing-point
highs. (See footnote on counting pullback days.)
1

The S3 support level was made at Trend Line 1. The next convergence of S3 was that it
occurred just above the .618 RT of 141.27, measured from the XIA bottom of 130 and
X2 top at 159.50. (This is not marked on the chart.)
I threw the curve at you to make the point that these convergences are important to
recognize at both significant and minor bottoms. Some of your major home runs will
come when the .38 level of the major leg coincides with the .618 level of the minor leg in
addition to the other convergences. If you get a good entry from convergence and it
coincides with a VIX signal for the market, it makes your trade even stronger.

Remember, these reference points are just alerts, not absolutes. You must then watch
for a reversal entry pattern that puts you in the trade. This might be a doji or hammer if
you are into candles or a close above the high of the low day, a three-bar reversal, a 1,
2, 3, 4 or even a 180. (See The TRADEHARD.COM Guide to Conquering the Trading
Markets, 1999, M. Gordon Publishing Group, Los Angeles,California.)
Regardless of which reversal pattern you use it is about getting in the trade when you
see it changing direction, not picking a bottom or top because it fits a number which are
just alerts. You should be looking for buying pressure to take the upper hand as price
and range expand on increased volume.

Now that you have framed GE on the daily chart, lets review the key points you should
be focusing on. After we do that we will combine these convergences with the Jan. 20
intraday chart. On Jan. 20, GE opened at 149.68, traded down to 142.625,then rallied
from this key level to 147.125 and this was your high probability trade.
A look at the daily chart shows me the following convergences:
1. The .38 RT level of X1 to X2 is 142.44. S3 support level is 142.56.
2. GE rallied last time from the S3 level of 142.56 which was right at the 50-
day EMA and Trend line 1. The 50-day EMA on Jan. 20 was 144.48.(See daily
chart bottom right.)
3. The S3 level of 142.56 where the rally started after an 8-day pullback was
just above the .618 level as measured form X1A level at 130 to the X2 top at
159.50.
4. The .618 RT level of 131.76 coincides with the S2 support level of 130.
5. The .786 level of 124.22 coincides with the 200-day EMA of 124.85
The key reference points which we have framed are enough convergence to have
entered the trade on Jan. 20, assuming you had a reversal pattern entry. We will have
more confirmation when you see it combined with the Volatility bands.
It is also important to observe the X2 top reversal. GE made the 159.50 top on lighter
volume and formed a dynamite triangle pattern as volatility contracted which usually
precedes a strong move. This is an excellent narrow-range pattern. The tighter it gets,
the biggerthe move in most cases. GE broke out of the pattern to the downside
in addition to trading below TL 2 and closed below the past 5 days lows. This was a sell
signal for any traders that were long and possibly a short entry for experienced traders
only. The question of whether you should short stocks in strong uptrends is another
topic and not part of this lesson.
Next, we will talk to the Jan. 20 intraday chart of GE where the low on that day of
142.625 converged with the .38 RT level from X1 to X2 on the daily chart in addition to
the other convergences we mentioned.
GE developed an air pocket on Jan. 20 as they reported record earnings but there was
confusion about a one-time gain and misplaced fears that the earnings were inflated by
the one-time gain. (Dow Jones News).
The overreaction started immediately as GE traded down to a low of 142.625. Any
short-term longs were stopped out and sold, some of the trigger happy institutions let
some go because they are all over weighted in GE big time. The married puts helped
accelerate the slide as the specialist was obviously going to let the stock fall to a level
that attracted buyers which it eventually did.
Hopefully you will soon become one of the few traders that take advantage of these
convergent opportunities.
In order to follow along on this intraday five-minute chart of GE, you should have a copy
of Short-Term Volatility Bands in your hands. The calculations are explained in that
strategy.
This example of convergence is to take a high probability day trade because on the
chart I have labeled the price bands from 1 to 2 standard deviations based on one
trading day. The calculation to get the one day constant is You divide 1 by 365, then
take the square root of the result and you get 0.0523421. Any calculator with a square
root function will do.
I have also marked the % probability that price will be contained within the volatility
band and probably revert to the mean. Translated, it means we are looking for trade
entries at the bands.
In this example, the 2.0 standard deviation band is 143.22 and there is a 95%
probability that price will be contained by this band. This assumes no unusual news
such as fraud or accounting irregularities.





Just so there is no confusion, I will do the calculation that gives us the
143.22 volatility band.
1. GE closed at 148.72 on Jan. 19, 2000.
2. Take the IV (Implied Volatility) of the ATM (at the money) call and ATM
put, add them together and divide by 2.
In this example, we used the most recent month options, which is
February expiration. I used the 150 strike price because GE was
closer to 150 based on its close of 148.72.
The result of this calculation gives you the combined IV of .354.
3. The constant is 0.0523421 and the combined IV is .354.
Example:
1. 2.0
(standard deviation x .354 (combined IV) = 0.708
2. 0.708 x
148.72 (GE) = 105.29
3. 0.0523421 x
105.29 = 5.541 points
4. 148.72 -
5.51 = 143.21 (2.0 SD, 95% band)
Note: You just add 5.51 to 148.72 for the upper 2.0 SD band.
You do the same calculation for each different volatility band, starting with the 1.0 SD.
GE dropped like a knife without a rally and gave a buy reversal entry at B1 with a
stop below the low of that first bar below 143. When it moved above 144, you moved
your stop up to break even, which was 143.50, the entry price.
The stock then dropped to 142.625, which was just above the .38 RT level on your
daily chart and just above the S3 support level of 142.56. GE gave an excellent
reversal-entry pattern at this level and the market dynamics were also better. You got a
wide-range bar (WRB) expansion, which was an outside bar that closed in the top of its
range, above its open, above the previous bars high and above the previous two bar
closes, and also closed above the previous low of the first entry pattern.


Once you entered at B2, there wasnt a reversal sell pattern until you got to the

147.125 level and reversed the lows of the previous 3 bars. Net net, you got back in at
143 1/2-5/8 and you had a defined exit at 146.75 assuming you took the reversal exit
pattern.
Combining time frames and convergences will definitely improve your trading or
investing as you can do the same framework with mutual funds, with the exception of
intraday bands. As you read this, you might think it is time-consuming to frame, but it
really isnt. Get some software that gives you Fibonacci retracement levels on your daily
chart and frame your key trading stocks or whatever stock shows up on your stock
selection list. If you are just trading intraday, you can frame the 0stock during the day
and look for entry points.
It is much stronger when you combine it with the intermediate trend. When you calculate
the volatility bands, start with 2.0, then 1.5, 1.28 and then 1.0. The best trades will
usually come from the wider bands. Please E-mail me on any questions you might
have. There is no such thing as a stupid question.
Good trading.
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When you count those 3, 5, 8 and 7 bar pullbacks, you arrive at the number by starting
with the most recent bar or the preceding bar in a situation where you are buying a
pullback in an uptrend (reverse for sellers)). If you have a double bottom, you count that
as one bar. More than that, you will be in a consolidation pullback.

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