Momentum Reversals in E-Mini Futures Contracts

By Toni Hansen

©2007, Reprinted with permission of The Trader’s Journal magazine (www.tradersjournal.com)

For many traders, the decision to trade the E-Mini futures market is viewed as a highly lucrative decision. The tax benefits and the ability to trade with relatively small starting capital thanks to the leverage makes it very appealing to many. In the stock market, the tax obligations and pattern day trader rule, which severely limits daytrading opportunities in stocks for those with accounts under $25,000 can be more of a turnoff. E-Mini traders can begin with an account of only $10,000 and still manage to make a decent living trading the market.

A market such as the E-Mini futures also has its drawbacks. Not only can a trader quickly run through his or her capital if they are not careful to manage their risk properly, but success in the futures market requires a much more substantial overall knowledge of market dynamics and price development than is necessary in the stock market. When trading stocks, a trader can more easily select just one pattern such as breakouts to master and keep him/herself relatively busy throughout the entire day. If they sat around and waited for that one pattern to emerge on a 5-minute or 15-minute intraday chart in the futures indices, it could be very easy to grow rather bored and complacent and be more likely to miss the set-ups when they do occur.

While a futures trader does not have to master all of the set-ups and strategies in the market, which would be impossible anyway, it certainly helps to have a handful to choose from that may vary in popularity given where they form in the larger market trend.

For instance, breakout patterns are some of the most widely followed strategies in any market. Although they can be used as reversal patterns, they are most easily recognizable when employed as continuation patterns within a larger trend move. In reality, a pure sideways trading range breakout is not that common in the futures market. The market spends more time in periods of congestion, moving back and forth than it does in a solid trend. So, in addition to the simpler trend-following systems such as breakouts and flags, it is also very important for a futures trader to have knowledge of counter-trend strategies and reversal patterns, which are not taught in great detail in most courses on technical analysis.

Most traders have a difficult time discerning when one trend is ending and another one is beginning. That is where this article comes into play. In it, I will share one of my favorite reversal strategies for trading intraday in the futures market (although it can be applied to a daily timeframe as well.) Each of the examples I discuss here take place in just one trading day and illustrate how commonplace set-up for the system is, even though it is not one you will ever hear much about.

When the pattern is discussed in technical analysis texts, they never go beyond the basic concept to explain the details of the set-up. Traders and educators who understand the building blocks of the strategy rarely share such knowledge. While I do not have room to get into all of the variations and applications of this set-up here either, I will strive to go beyond the basics to relay a very solid, very profitable, set of criteria for timing some of the major reversals in the market.

The pattern I am about to describe is one that I have named the Momo Reversal. Momo simply refers to ‘momentum’ and the pattern itself is based upon a shift in the momentum of an index. For those unfamiliar with the term momentum, it refers to the rate of price change within a given time period. For instance, if the ES (S&P E-Mini 500) moves 3 points in 20 minutes and then moves 1 point in the next 20 minutes, then the momentum of the first 20 minutes is three times greater than in the second 20 minutes.

The Momo Reversal pattern is one where I monitor a shift in momentum within a trend move as support or resistance levels are hit. A trend is the primary direction that price is moving in a security. For instance, if the ES is making higher highs and higher lows, then it is considered to be in an uptrend. Conversely, lower highs and lower lows indicate a downtrend.

This reversal pattern is applicable to both types of trends and can be used to time reversals off either the highs or the lows of a security on any timeframe it is applied to. Intraday, I have used it on everything from a 25-tick chart in the NQ to a 120-minute timeframe chart.

Support and resistance levels are price levels where prices are likely to stall or reverse a trend move. The larger the time frame a support or resistance levels hits on, the more likely it is that a reversal pattern will form at that level. Similarly, more support or resistance levels there are hitting at approximately the same time will enforce those levels and make them much more difficult to break.

An example of a resistance level on a 15-minute timeframe is at a prior day’s high. For example, let’s say that the ES hit 1585 on Tuesday and then pulled back on Wednesday. If it retested the 1585 zone on Thursday, then the 1585 level would represent a price resistance level. If a pattern such as the Momo Reversal formed heading into this resistance zone, then the odds are much higher that the level will hold and the set-up would be successful.

There are several traits that I look for when identifying this particular reversal pattern. The first one is the nature of the trend itself. The Momo Reversal consists of three waves of buying in the case of a reversal pattern forming off highs. This would be classified as an uptrend. It means three highs need to be established with each of the successive highs being higher than the first and each of the two lows also higher than the first.

Within the uptrend, the strongest and largest move within the uptrend needs to be the first wave of buying. Each of the two additional moves should diminish in magnitude, much like the aftershocks of an earthquake. The second should be smaller than the first and the third move should be smaller than the second. Ideally, each of the previous highs will break by a lesser degree as well. For instance, if the second wave of buying breaks the first high by 6 ticks, then the third move into highs may only break the second high by 3 ticks, although this will not always be the case.

As the uptrend hits its third high, this is the high that should be hitting some sort of price resistance to allow for the strongest reversals. When the market is making new highs, rely on things such as whole number resistance. A good example of this is the Dow at 14k.

For those unfamiliar with the term, a tick is the minimum price movement of an E-Mini contract. In the S&P 500 E-Mini (ES), a tick on one contract is worth $12.50. In the NASDAQ 100 EMini contract (NQ), it is worth $5. In the Mini-Dow Jones Industrials (YM), it is also worth $5. In the E-Mini Russell 2000, (ER) a tick is worth $10.

While I do not display any volume data in the examples I have chosen for this article, the volume often diminishes within each of the final two waves of buying in the trend. This does not work on a tick chart where movement is based upon the contracts that have exchanged hands at various price levels, such as the 50 tick charts shown below. However, it can be extremely helpful when using charts based upon a division of time, such as a 5-minute chart, a 15-minute chart or even a 1-minute chart. Although declining volume is not absolutely necessary, it certainly helps! It should be viewed as an additional bonus because it adds strength to the set-up’s chance for success.

Click here to view Figure 1

Click here to view Figure 2

There are several ways that the Momo Reversal short pattern can form. It can serve as a smaller uptrend within a larger downtrend, where the pattern ends up triggering a continuation of the larger trend move. Or, it can serve as a reversal pattern within a larger trend move and form at the highs of a final leg of buying in that trend. It can also form within a trading range, moving prices from the highs to the lows of the range.

The first example of the Momo Reversal pattern shown is a typical one found within a larger trend and acting as a continuation pattern to an earlier move. In this case, the initial move was a reversal off highs shortly after the opening bell. The minisized Dow Jones (YM) sold off quickly, but reversed off of lows around 10:00 ET. This marked the beginning of the Momo Reversal pattern.

The first noticeable trait of the pattern’s formation was the very rapid move higher coming out of 10:00 ET. The initial upside off the lows was even stronger than the decline into them. At 14173, the YM established what would become the first high in the reversal pattern. Then YM pulled back to 14157 at 10:05 ET, creating the first correction and higher low in the new uptrend.

A second high formed at about 10:10 ET. This higher high broke through the first pivot high by 2 ticks to hit 14175. While the YM corrected for a second time off highs, it made a much higher low to show a greater price difference between the lows than the highs were now displaying. The YM broke the highs by 2 ticks, but it put in a higher low with a difference of 7 ticks from the second low to the third before moving to new highs and breaking by another two ticks for a high of 14177. The implication was that the bulls were beginning to feel the pressure and were not as eager to buy more, but the bears were not quite committed to their positions either.

The commitment level changed coming off of the third high. The YM fell quickly into the lows of the channel made by connecting each of the prior two lows. However, instead of bouncing off of it, it stalled and began to chop around. It failed to attempt a fourth high and the YM was breaking the lower channel and triggering a short pattern soon after 10:15 ET. The third high of the uptrend becomes resistance and is the level it must break in order to trigger a stop on the Momo Reversal.

Assessing target levels on this pattern can be rather daunting. While the entry and exit prices are easy to locate, it can take a bit more skill to locate the proper support level that will hold once prices begin to drop. The reward potential of this set-up often depends upon where it takes place in a larger trend and how much room it has to move from the time it triggers until it hits price support.

The typical support levels I look for in a target are prior pivots off lows and earlier levels of congestion. If a prior pivot low is 2150 in the NQ for instance, then as the NQ is within a point or so of that low, I will look to take at least part of my position off. If the pattern is part of a much larger trend reversal, then I will be more willing to hold for larger compensation. The above example of the YM shows how the 10:00 ET lows served as initial support, which stalled the move for a few minutes, but the YM continued into a larger time frame support level from the previous session.

I find that I can often get at least two waves of selling, meaning an initial decline, followed by a bit of correction off the first support, and then a second wave of selling before larger support holds and the index reacts more strongly with greater price corrections.

A second variation of this set-up takes place later in the afternoon on the same trading day. This time around, the initial momentum on the upside is the strongest of the three waves of buying, but the second wave is not that much more gradual. It is a bit choppier, however, with three smaller waves of its own. This creates a more gradual overall momentum for this second wave of buying into the 14:30 ET zone. A second correction follows, leading to a third high on the YM around 14:50 ET. This time there is a much closer relationship between the two highs. The third high of the trend is only slightly higher than the second. It is enough to trap new bulls buying the break to new highs, but not enough to display any conviction on the attempt itself.

As the YM falls from the afternoon high, it does not pause to form any congestion at the lower channel line like it did earlier in the session. While the stop was rather wide in this case, the probability for success on it more than makes up for the risk over time. The first support level from the 14:10 ET zone more than covered the stop level and the second support from congestion earlier in the session allowed those holding the position as a short to achieve up to 2.5:1 reward vs. risk before the index turned around and reversed again at about 15:30 ET.

The 15:30 ET reversal in the YM following that Momo Reversal short pattern off the highs was another Momo Reversal in and of itself. This time, however, it was a buy set-up. All of the same criteria apply on the buy side as on the short side. The initial decline off the 14:50 ET highs was the strongest move of the new downtrend. The second move began around 15:10 ET and continued into about 15:15 ET. It was only about 2/3 of the initial decline in terms of the price move. The third move was the choppiest and took the YM back into that lower trend channel support for the last time. The buy trigger came only moments later at about 15:35 ET, leading to another two waves of upside as the YM eventually made it back into the zone of those prior 14:50 ET highs. Of course, these were the third highs on the last Momo Reversal short.

The Momo Reversal pattern is a pattern that I come across nearly every day in the market and typically a number of times throughout the day. While there are certainly a number of other patterns for timing price reversals, I have found this pattern and the other manifestations of this pattern to be the most reliable and it has become one of my most popular strategies.

Toni Hansen (https://www.tonihansen.com) is a full time trader who has spent the past decade immersed in the market. A popular speaker and columnist, Toni spends much of her free time sharing her knowledge with others. A pure technician, her simple trading style, which focuses on price and volume activity, transcends both time frames as well as market vehicles, allowing even the most inexperienced of traders to rapidly learn the building blocks that make up her successful trading methodology. Information on her new CD course in which she details the key building blocks of her trading system can be located at https://www.swingtrader.net.