ETF vs Component Divergence

Entry Logic

• Exact Entry Trigger: Short an ETF when its price makes a new high, but a major component stock fails to make a new high.
• Confirmation: The component stock should show a bearish divergence on the 1-hour RSI.
• Timeframe: 1-hour chart for entry and analysis.
• Location Context: The ETF should be at a resistance level.
• Market Condition: A market that is showing signs of weakening momentum.

Exit Logic

• Profit Targets: The 21-period EMA on the 1-hour chart.
• Scaling Out: Not recommended.
• Trailing Stop: Trail the stop above the high of each new 1-hour candle.
• Signal Failure Exit: Exit if the ETF and the component stock both make new highs.
• Opposite Signal Exit: Not applicable.
• Time Expiration: Exit at the end of the day.
• Momentum Loss: Exit if the 1-hour RSI on the ETF drops below 30.

Stop Loss Structure

• Hard Stop: 1 ATR (14) above the high of the entry candle.
• Soft Stop: A close above the entry day's high.
• Max Dollar Loss: 0.5% of account equity.
• Max Percent Loss: 1.5% of the position's value.
• Structural Stop: Above the most recent major swing high.

Risk Management Framework

• Risk Per Trade: 0.5% of the account.
• Maximum Daily Loss Limit: 1.5% of the account.
• Maximum Weekly Loss Limit: 3% of the account.
• Maximum Drawdown: 10% from peak equity.
• R:R Requirement: Minimum 2:1.

Position Sizing Model

• Sizing Approach: Fixed fractional sizing.
• Volatility Adjustment: Position size is adjusted based on the 14-period ATR.
• Conviction Sizing: Not applicable.
• Scaling In: Not recommended.
• Scaling Out: Not recommended.

Trade Filtering

• Market Conditions to Avoid: Strongly trending markets.
• Specific Setups Required: A clear divergence between an ETF and a major component.
• Instruments: Liquid ETFs and their top 5 holdings.
• Time Restrictions: No specific time of day restrictions.
• Chop/News Avoidance: Be aware of news that could affect the component stock.

Context Framework

• Trend Direction: The ETF is in an uptrend, but showing signs of exhaustion.
• VWAP Relationship: Not a primary consideration.
• Moving Average Relationship: The ETF is extended from its moving averages.
• Range Location: The ETF is at the top of its recent trading range.
• Higher TF Alignment: The daily chart should also show signs of weakening momentum.

Trade Management Rules

• Breakeven: Move stop to breakeven after the price moves 1R in your favor.
• Scale Out: Not applicable.
• Add Size: Not applicable.
• Fast vs Slow Moves: This is a counter-trend strategy, so moves can be fast.

Time Rules

• Optimal Trading Window: No specific window.
• Times to Avoid: Not applicable.
• Session Notes: Not applicable.

Setup Classification

• A+ Setup: A clear divergence with a major component stock at a key resistance level.
• A Setup: A divergence with a smaller component stock.
• B Setup: A weak divergence.
• C Setup: No divergence.

Market Selection Criteria

• Instruments: ETFs with a high concentration in their top holdings.
• Volume/Liquidity: High volume and liquidity are essential.
• Volatility: The ETF should have sufficient volatility.

Statistical Edge Metrics

• Expected Win Rate: 40-45%.
• Average Win Size: 2.5x the average loss.
• Average Loss Size: 1x the defined risk.
• Profit Factor: 1.5 - 1.8.
• Expectancy Per Trade: Positive, aiming for > 0.2R per trade.

Failure Conditions

• Market Conditions: Fails in strongly trending markets where divergences are ignored.
• Specific Scenarios: The component stock breaks out and makes a new high, invalidating the divergence.

Psychological Rules

• Key Mental Discipline: Requires the ability to short a strong ETF. This can be psychologically challenging.

Advanced Components

• Market Regime Detection: This strategy works best in a market that is transitioning from a trend to a range.
• Volatility/Liquidity Filters: Essential.
• Correlation Filters: Not applicable.
• MTF Alignment: Daily chart confirmation is beneficial.

Location

• Where Strongest: At key resistance levels in a market that is losing momentum.
• Where Weakest: In strongly trending markets.