SMT Divergence Explained | ES Trade Breakdown | ICT Concepts

Introduction

In this tutorial, we will explore the concept of SMT (Smart Money Tool) Divergence and how you can leverage it in your trading strategy. By understanding SMT Divergence, you can identify the strengths and weaknesses of correlated assets, which is crucial for making informed trading decisions. We'll break down a real-world trade example using the E-mini S&P (ES) during the Non-Farm Payroll (NFP) report in April, demonstrating step-by-step how to apply these concepts effectively.

Step 1: Understand SMT Divergence

• SMT Divergence refers to the correlation between two assets at key highs and lows.
• It helps traders identify which asset is stronger or weaker:
  • In a bullish market, focus on longing the stronger asset.
  • In a bearish market, focus on shorting the weaker asset.
• Visualize the concept:
  • If one asset fails to make a lower low while its correlated pair does, prioritize trades on the stronger asset.

Step 2: Analyze Market Conditions

• Use daily charts of correlated assets like the S&P, NASDAQ, and Dow Jones.
• Mark key highs and lows:
  • Identify the Monday high and the lows leading into Friday's NFP.
  • Look for divergences:
    • A higher low in a bullish asset (like ES) against a lower low in a weaker asset (like YM) indicates strength.
• Note the following:
  • If the stronger asset takes out buy-side liquidity but the weaker one fails to take out the corresponding high, consider shorting the weaker asset.

Step 3: Time Frame Alignment

• Transition from the daily chart to the 1-hour chart:
  • Carry over key levels identified on the daily.
  • Observe the lows on Friday and confirm if they match your analysis.
• Look for additional SMT Divergence:
  • If the NASDAQ makes a new lower low while the ES holds a higher low, this reinforces the bullish bias on ES.

Step 4: Execute Your Trade

• Move to a lower time frame (e.g., M5) for detailed analysis:
  • Wait for the market to open at 9:30 for clearer liquidity signals.
  • Identify key price levels and potential entry points.
• Set up your trade:
  • Look for a run on buy stops below a recent low.
  • Place your entry at a high-probability order block once price confirms a shift in market structure.

Step 5: Manage Your Trade

• Use risk management strategies:
  • Set your stop loss below the identified intermediate term low.
  • Aim for a risk-to-reward ratio of at least 1:2.
• Monitor price action:
  • Wait for confirmation of a bullish move above the previous high.
  • Be prepared to adjust your exit strategy based on market conditions and price behavior.

Conclusion

By understanding and applying SMT Divergence, you can enhance your trading strategy and make more informed decisions. Always focus on identifying the stronger and weaker assets in a correlated pair and utilize multiple time frames for analysis. Remember to practice risk management to protect your capital. As you backtest and forward test these strategies, you will likely find yourself on the right side of the market more often, leading to improved trading outcomes.