Saturday, May 14, 2005
Price - Indicator Divergences
Traders spend hours tinkering with methods that will give them an edge better than simply flipping a coin. One such edge is to use an indicator on price. Depending on the complexity, indicators are at least one step removed from price. Even so, unless you are trading at lightning speed, indicators can be a useful aide to decision making.
One aspect of RSI, MACD, stochastic, CCI, and similar oscillators is that, while intrinsically lagging, they will set up divergences with price that can be exploited by the trader.
In the example at the end of this article, taken from todays ES e-mini, I've marked up various
Divergences and
Reversals. Divergences are fairly well known and, for many, easily spotted, as price goes in one direction and the indicator goes in the opposite. It is called a Positive Divergence when in a downtrend and a Negative Divergence when in an uptrend.
Reversals may take more screentime to recognize, but from my swing trading experience, I've found them to be patterns well worth study. Connie Brown discusses these in her book,
Technical Analysis for the Trading Professional, and credits Andrew Cardwell with teaching her the method. While called a reversal, they often appear within a range and signal continuation after a short pullback reversal. Reversals are also called "Hidden Divergences" and
Buffy's article goes into further depth on both. Additionally, there are scores of examples at
dacharts here and
here for further study.
One useful aspect of these Reversals is that they provide a measuring target, as shown below.
Finally, here are some divergences found on a tick chart during today's trading. These two indicators are RSI and Stochastics, the shorter one giving more signals in this case, but virtually any indicator will generate divergences.
Labels: indicators
At last, over the rim
of the waiting earth
the moon lifted with
slow majesty
till it swung clear of the horizon and rode off,
free of moorings
- Kenneth Grahame,
The Wind in the Willows
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