Eric Sarratt's
Investment Education Services                       Trading Method

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My primary entry method for selling short consists of four conditions:
   1) After price begins to trade around or through the 200 day moving average...
  
Conditions 2 and 3 can occur in either order, but both must occur:
   2) Price puts in a double top
   3) RSI puts in a divergence (a.k.a. negative divergence)

   4) Price closes below the trend line

Now we have a new trend and I will only trade this stock/commodity/currency from the short side using pullbacks and breakouts from chart patterns.

Example: Going Long the Euro-British Pound Currency Pair (EUR/GBP)

1) After a precipitous decline...

2) Price puts in a double bottom

3) RSI puts in a convergence (a.k.a. positive divergence)

There is an additional convergence in RSI. Can you see it?

There it is!

This additional convergence only adds to our conviction that direction has changed.

Your mouth should begin to water when you see setups this good.

So, why does all this work?

• Double bottoms are a price pattern that often correlate with a directional change in price.
• RSI goes up or down in relation to where price closes each day (Remember: Upward trends are marked by higher closes and downward trends are marked by lower closes). So by comparing a statistical calculation—a derivative of price action which is converging with price, we can speculate that the overall direction of price will soon follow.
• And I added in the requirement of a trend line break because I was getting too many false signals; trend line breaks are a price pattern that can also result in a change in trend.

The nutshell version is, we're playing the odds. Lets see how well we do.

An entry was initiated on July 9th for 475 units. Note: my entry is a little late, but that is OK.

Additionally, a stop loss point was placed at 0.83880—the red horizontal line; if price goes past this point I take a small loss.

A second entry was initiated on August 7th for 575 units and a second stop loss was placed at 0.83381.

Why did I put on a second trade? And why did I make my second stop lower than the first?

The first answer is easy to understand. There is:
• Another convergence in RSI
• Another double bottom
• Price is going in the direction I thought it would

The second answer is personal trading style and experience. I was concerned the market would continue to go sideways a bit longer before obviously changing direction and so I put on a wider stop to give the trade more wiggle room. I don't like to be stopped out because of a wiggle.

But, as it turns out, I did not need the extra wiggle. The second double bottom and convergence was enough for the rest of the market to jump on and I exited both positions three weeks later on August 28th.

Why did I exit the trades?

God. Colloquially the 200-day moving average (the red line) is referred to as "God" by some market participants. God rules all and stops everything in its tracks. I figured the market would pull back here so I took profits and decided to wait and see how the market reacted to the 200-day MA.

Alternatively I could have left the trade on and moved my stops up or left on a percentage of my positions and let them run (this is probably the smartest thing to do), but I like to be a little more active. To each his (or her) own.

I hope you enjoyed this lesson. Feel free to contact me if you would like me to speak at your group or if you are interested in becoming my student. I have much more to teach.