Breadth Divergence Reversal

Entry Logic

• Enter long when the market makes a new low but the advance-decline line makes a higher low.
• Confirmation is a bullish candlestick pattern on the daily chart.
• Use a daily timeframe for this setup.
• Entry should be above the high of the confirmation candle.
• This setup works best at the end of a correction in a bull market.

Exit Logic

• The profit target is a new high in the market index.
• Scale out 50% at the previous high.
• Trail the remaining position with the 50-day SMA.
• Exit if the market makes a new low.
• Exit on a confirmed bearish breadth divergence.
• Exit if the trade is not profitable within 3 months.
• Exit if the MACD shows a bearish crossover.

Stop Loss Structure

• Place a hard stop below the low of the divergence pattern.
• A soft stop is a close below the 50-day SMA.
• Maximum dollar loss is $3000 per trade.
• Maximum percent loss is 6% of the account.
• The structural stop is below the low of the confirmation candle.

Risk Management Framework

• Risk 3.5% of the account per trade.
• Daily loss limit is not applicable for this timeframe.
• Weekly loss limit is 12% of the account.
• Maximum drawdown is 50%.
• Minimum risk-reward ratio is 3:1.

Position Sizing Model

• Use a portfolio allocation model for this strategy.
• Allocate a certain percentage of the portfolio to the market index ETF.
• No conviction sizing is used.
• Do not scale into trades.
• Scale out at the previous high.

Trade Filtering

• Avoid trading this setup in a bear market.
• Requires a clear bullish breadth divergence.
• Trade only the major market indices.
• Avoid trading this setup during times of high uncertainty.
• Do not trade in markets with no clear trend.

Context Framework

• The weekly chart should show a clear uptrend.
• The economic cycle should be favorable for the stock market.
• The setup should occur after a healthy correction.
• The monthly chart should show a bullish bias.

Trade Management Rules

• Do not move the stop to breakeven until the first profit target is hit.
• Scale out 50% at the previous high.
• Do not add to winning trades.
• Be patient, as market reversals can take time to develop.

Time Rules

• This setup can be identified at the end of the trading day.
• The entry is taken on the following day.
• The trade can last for several months.

Setup Classification

• A+ setup: Strong breadth divergence, clear confirmation candle, favorable market conditions.
• A setup: Clear breadth divergence, moderate confirmation candle, neutral market conditions.
• B setup: Weak breadth divergence, no clear confirmation, unfavorable market conditions.
• C setup: No clear divergence, avoid.

Market Selection Criteria

• Trade major market index ETFs (SPY, QQQ, IWM).
• The market should have a history of responding to breadth signals.
• The market should have a high level of liquidity.

Statistical Edge Metrics

• Expected win rate is 80%.
• Average win is 4R.
• Average loss is 1R.
• Profit factor is 3.2.
• Expectancy per trade is 2.2R.

Failure Conditions

• The strategy fails if the divergence does not lead to a reversal.
• A common failure is a continuation of the downtrend after a brief pause.

Psychological Rules

• Have the conviction to buy when the market is weak.
• Do not get shaken out by short-term volatility.

Advanced Components

• Use other breadth indicators, such as the McClellan Oscillator, to confirm the divergence.
• A sentiment indicator can help gauge market fear.
• Avoid trading this setup when the VIX is elevated.
• The weekly chart must confirm the uptrend.

Location

• The setup is strongest at the end of a correction in a bull market.
• The setup is weakest in a bear market.
• The location of the divergence in the overall market trend is critical.