DIVERGENCES BETWEEN PRICE AND SL DIVERGENCES BETWEEN PRICE AND SL A PRICE/MOMENTUM DIVERGENCE OCCURS WHEN the paths of the price and a momentum oscillator diverge, i.e., move differently from one another. Both price and momentum oscillators move up and down. In this up-and-down movement periodic highs and lows are made. Naturally, these periodic highs and lows are only clear afterward;however, once clear they can then be compared to a previous high or low as to whether they are higher or lower. A price/momentum divergence occurs when either the price or oscillator makes a higher high or lower low, and the other does not. The idea behind price/momentum divergences is that the momentum oscillators tend to be a "truer" reflection of internal price strength or weakness than the price itself. The theory is that if and when the oscillator is diverging from the price in terms of its current versus previous high or low, then treat the oscillator as the better (than price) indicator of most likely future price action. For example, if the price makes a higher high but the oscillator makes a lower high, this indicates a lessening of upside price energy and the likelihood of some near-term price weakness. The chart on the facing page (June 2002, Canadian Dollar) contains multiple price/momentum divergences. Keep in mind that divergences are always very clear after the fact, but not so clear as they are happening. Generally, divergences have to be anticipated; however, doing so is not that difficult once you know how to anticipate the movement of the oscillators. Compare points 1A and 2A (of the SL) to points 1 and 2 (on the price chart). Point 2A is clearly higher than point 1A, yet the price at the comparable point 2 is clearly lower than point 1. Therefore, the oscillator was showing a definite decrease of downside price momentum despite the fact that the price had pushed to clear new lows. This was a sign of probable near-term price strength and that is exactly what happened. Next compare points 3A and 4A of the SL to the comparable price points 3 and 4. Note how the price made a slightly higher high, while the SL made a slightly lower high;this indicated a decrease in upside momentum and was a sign of some probable near-term price weakness. Again, that is exactly what happened. Price/momentum divergences are a useful tool in trading; however, they are far from perfect and therefore should only be used as an additional indicator. Divergences should not be allowed to override otherwise solid price energy flows of trend, ML and SL. A few basic rules on divergences: 1 ~ Divergences where the difference in highs/lows in the SL are great but those of the price less so tend to be more reliable than vice versa; 2 ~ Multiple divergences (such as those at points 5A, 6A, and 7A) tend to be more reliable and result in longer lasting moves than single divergences (such as the one at 1A/2A); 3 ~ Divergences occurring with the trend tend to be much more reliable and lasting than those that occur against a trend, especially when the trend is strong. BOTTOM LINE ON DIVERGENCES Pay attention to potential and actual divergences, and act on them when they are with the prevailing price energy flows (trend/ML); however, be careful not to overweight them (especially when they come against a clear trend).