DIVERGENCES BETWEEN PRICE AND SL.docx 16

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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).

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 views: 3 posted: 10/9/2012 language: pages: 4
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