Providing investor education, product enhancements and software solutions on how to become a more successful online trader with The Investrio Mentor Center. Understanding the Stock Market The purpose of today's column is to provide you with invaluable insights into the Stock Market. Today’s Topic: DIVERGENCE SIGNALS In our last few articles we have discussed continuation patterns and how to anticipate pull backs and runs within these patterns. There are numerous stocks in the market that are currently forming flags, pennants and triangles. I would suggest reviewing the last few articles to help find these stocks and determine where potential entries can occur. This week we will be discussing divergence signals. They are called divergences because the stock trends one way (uptrending), but the volume or supporting indicator is actually moving in the opposite direction. In other words, it refers to a situation where different technical indicators fail to confirm one another. While here it is being used in a negative sense, divergence is a valuable concept in the market analysis. It is one of the best early warning signals of impending trend reversals. Sometimes in our analysis of technical indicators we fail to recognize early indications of change. We tend to focus much of our attention on the price action or trend. When this happens, we forget some of the technical indicators that measure sentiment and momentum for our stock. We see that our stock continues to rise and there isn’t any sign of roll over…or is there? Watching for divergences in your technical indicators can help rescue you from a sudden change of trend. The first divergence we will discuss shows up in volume. This is illustrated by the following chart. Here we see in Siebel Systems, Inc (SEBL) two depictions of a volume divergence. The stock is trending upward, but the volume in correlation with that trend is drying up. It is important to notice that as the trend continues, the amount of volume is decreasing and the volume bars are progressively getting smaller. This is an indication that the momentum of the trend is weakening and the bulls are slowing down. Also, it shows you that things could be changing or the buying power to keep the trend alive is disappearing. It could be an early detection that the sentiment may be weakening as well. However, you must remember that divergences are simply caution or yellow lights. They aren’t red or green lights to get in or out. You should continue using your technical indicators as the confirmation that the position has changed. Remember, a divergence is a good forewarning to alert you of a consolidation or reversal on the direction of the stock. Watch for volume divergences in all your positions. They will help alert you to potential pitfalls and reversals that may sneak up on you if you are only watching the trend. Also, the volume divergence helps detect the continued strength of your position and may give you an indication of an early exit. Next week, we will continue our discussion on divergences and give some more supporting indicators that will help determine whether a true divergence has occurred. Thank you again, for the opportunity to share our knowledge and experience with you. “More Millionaires have been created from the stock market than any other source” --Bloomberg Magazine Click Here for a free 10 day trail of our Software, Education & Trading System. Copyright © 2000-2003 Wall Street Mentors Inc. All Rights Reserved. Member Access |
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