vlad.adrian
Short

The Dow - Divergence analysis. What's next?

INDEX:DOWI   DOW Industrials
864 7 11
Why is it so easy when you look back?? Well, probably because there is no emotion at analyzing the past. As you can see, there is a pattern going on here.

I'm sure you heard the saying 'divergences are the holly grail of trading'. Well, a look at what happened after the crash of 2008 and it definetely sounds or better say, looks true.

There is nothing much that needs explanation, the divergences warn about future market direction. Look how most of the corrections were announced by divergences, and look how most of the corrections started with a candle pattern, more important the covering patterns (engulfings, dark cloud and piercing line, they all cover the previous candle). As I stated in the chart, on the weekly it's harder to get a proper candle pattern, by that I mean the lack of gaps. It's a weekly chart, there aren't big changes over the weekend in market consensus.

Let's concentrate on the latest signal, that is what can make money for us. All around the world there is a selloff, especially in emerging markets and their currencies. The argentian peso lost 17% in a day, turkish lira is at new highs every day, South african rand posts multi anual highs, yen gaining through all its crosses. The bigger markets are also down. There are many reasons for this, which I won't state because I do not have the knowledge to explain them, it is just information taken from various papers and from two fundamental analysts from my country that I trust. The trigger of this selloff was the low Chinese manufacturing PMI, after the release Japan went down strongly two days in a row, I was long the Nikkei, got stopped out. The situation continued in Europe, then in the US. Today, it looks the same, massive selloff everywhere. I'm sure there will be a pause, when I am going to look for an entry to hedge my US market positions.

Looking only at the chart, I need to say that it is important for the week to close like this, with a big red candle, At the time I am writing this, there is a bullish divergence on the hourly chart of the Dow, but it is probably only a sign for a correction. Looking back at the last months, We had sort of a head and shoulders , formed in september-november, by the tappering and the government shutdown debacle. After that, we started rallying again, retesting and then again rally. A very big class A bearish divergence is screaming at us (at least at me) to stop going long and look for shorts. The pattern is on most stocks, but I've been ignoring it, expecting only minor corrections which wouldn't affect my positions. After this week, I'm starting to take it more seriously because we also have an engulfing candle after four weeks of indecision. About two weeks ago I expected a small correction on the US market, I posted an ideea where I said that it would be great if we would stop at the first support zone . Well, we did, but I'm not sure about the great part. Things don't look good here, don't look good in Spain, Germany, Japan, Turkey, anywhere aroung the world. Divergences were screaaaaming on every chart you could look at. Well, now the correction started, the question is when will it end?? Today, next week, in a month?? I do not know, but I am very bearish for the short term.
Two weeks have passed and the Dow did as predicted : correction to the dynamic support 34 EMA(low) and then started a rally. Now we have a weekly hammer which points to a good week up ahead.
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Great One
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thumbs up!:)
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Nice stuff vlad and you quite nailed it.. Any particular reason you use MACD for divergence instead of RSI?
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vlad.adrian PRO justatrader
Well, maybe this is going to sound weird but I like the roundness of the MACD lines. Let me try and explain a bit cause after reading that you probably think I'm crazy. The RSI is much more volatile, and sometimes I find it harder to time the divergence. What I mean is that after I spot the divergence on the MACD, I take a look at the histogram in order to see if there is a chance for it to continue rising or go down and confirm the divergence(in this case bearish divergence). When I look at the RSI, after spotting the divergence, I do not have the second filter, such as the histogram. Sure, you can use the direction of the RSI, but I find that more volatile. I don't know if I managed to explain it properly, it is a bit harder by writting, and after all I guess it is just a matter of preference. I am testing a forex strategy right now and for that I use the RSI, I find it easier to spot divergences on forex with it.
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I like your "Class A" and "Class B" divergences. Also nice is the "Hidden bullish" labels. The chart isn't messy at all. Easy to understand. Thanks for the comments.
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Thank you! Unfortunately, I do no see that often people taking into account the 'class' of the divergence, which after all shows us how strong the divergence really is. I'm not sure about this, but I think that the only book of technical analysis where I found this interpretation of divergences was in one written by Dr. Elder, but there must be more written about this.
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