Divergence!

Just a few days back I had written about divergence. Well it’s a favorite trade set up of mine so thought would make another post out that with illustrations. Two reasons for doing this, one, this is my blog, two, I wanted it in my blog for future reference. As Pring states when the momentum and price are moving in tandem, there isn’t much to read other than assuming we have a healthy trend. It is when the momentum and price get out of sync we have Divergence in hand.

There are 2 basic types of Divergence.

REGULAR DIVERGENCE

1-Price is making higher highs while the indicator is not: Bearish

2-Price is making lower lows while the indicator is not: Bullish

HIDDEN/REVERSE DIVERGENCE

3-Indicator is making higher highs while price is not: Bearish

4-Indicator is making lower lows while the price is not: Bullish

Divergences test your patience, you have to let them develop and then get ready to put in your trade. One of the mistakes us novices make is we jump the gun too soon when we spot Divergence. It should be remembered (I might as well put this in bold font to drive home the point), Divergences in themselves do not signify a reversal or a trend change, they merely gives us an advanced warning of the underlying strength or weakness in the prevalent trend. The real confirmation comes from the Price action itself.

There is a lot one needs to understand about Divergence, than these simple interpretations. The significance of Divergence, the Divergence Trap and Complex Divergence (will add these later). I reiterate again that one should read Pring’s book on Momentum to get better hang of things. Divergences if traded right, can give phenomenal trades, but then you need to spot them, and wait patiently to let them develop, and finally pull the trigger when the PRICE gives the signal!

The Bear Necessities !!!

Well I shouldn’t have posted Death Cross (ominous!!!…it is a prelude to more bearishness). And speaking of bearishness, I decided to spend some time reading a book on Bear Market. Three hours of serious reading!!!(ok..so u caught me..I confess…one hour was spent on serious reading ,the next two pretending that I was still seriously reading!!!). There is an old adage, which says that knowledge can be communicated but wisdom has to be self-taught (yeah! Yeah! I am tryin my hand at wisdom!).

So I get the wisdom and you get the knowledge communicated to you by this post. Ready…..so here it goes..

Lets see what Charles Dow had to say years ago:

‘‘It is a remarkable fact in speculation that both the average price of

a number of stocks and the price of individual stocks show strong

tendencies, both in rallies and relapses, to reach one half of all the

primary movement. When a stock falls ten points in a comparatively

direct move, it is extremely likely to rally as much as five points from

the lowest. It often rallies or relapses more than half of the original

swing, but it is generally safe to wait for about half.

‘‘A Comparison of the Averages . . . shows how regularly this

movement occurs. When a recovery does not come near being one

half of a decline, it generally means that the primary movement has

not been completed and that a new low quotation will be made.’’

And now lets see what Rhea says..Rhea who???. Robert Rhea, who was a hugely

successful investment advisor during the 1930s says :

‘‘Bear markets seem to be divided into three phases: the first being

the abandonment of hopes upon which the uprush of the preceding

bull market was predicated; the second being the reflection of the

decreased earning power and reduction of dividends; and the third

representing distress liquidation of securities which must be sold to

meet living expenses. Each of these phases seems to be divided by a

secondary reaction which is often erroneously assumed to be the

beginning of a bull market.’’

I some times wonder why these guys could not say anything in plain English…maybe they wanted a few educated to understand them….that way you have more ignorant in the market(conspiracy theory at work here I guess…the less the people understand the more money they will loose!!!) Anyways, Simply put, a Bear Market in stocks comes about because the prices get too high in relation to their value. This is caused by public enthusiasm that

gradually becomes excessive, appraising stocks out of proportion to their ‘‘true’’ earnings.

It is the nature of such things to go to extremes in both directions. So, as a bull market often goes too high, so too does a bear market go too low. The excesses are caused by human emotions.

So when does a Bear Market start???

Its simple…Bear Market starts when Bull Market ends!!!(told u the KISS element!!!).

But how does one know that the Bull Market is showing THE SIGNS!!! (of declining).

• Investor sentiment is still bullish while the underlying economic structure continues to weaken.
• Price earnings ratios…crazy valuations!!!. To return to a more traditional price earnings ratio,the market need to correct.
• The Federal Reserve….. driving interest rates down… with no result, it is increasingly clear that when the economy goes south, there is little government can do to stop it.
• Gold…. the interest in gold and gold shares picks up.
• Stocks… At tops, there is what is commonly classified as ‘‘churning’’ (i.e., high volume but not much change in prices, or great irregularity in prices [some up sharply, some down sharply], plus a lot of volatility day to day).
• Unanimity of bullish forecasts. Any downturn is dismissed as temporary.
• Sharp rise in debt. Consumer debt, household debt service payments, losses by credit card issuers, bankruptcy filings and mortgage delinquencies all rise sharply.

And how does a Bear Market shows time for its hibernation???

• Bad news abundant. And the market acts contrary to the obvious.
• Stock Market. Volume tends to increase on rallies, decrease on dips.
• Confidence. Nil. Pessimistic forecasts made for the market and for business.

Ahem!!! I guess that’s enuff for a brief note.And by the way all Bears are not Sinister some are cute too. Any lessons???Yesssss……If only I had researched for this when Nifty was riding 6000 I would have been a rich man!!!! But like I always say just tryin2trade!!!!

ADX

ADX!!!

A friend of mine forwarded me a very nice and a practical write up on the ADX by Ty Young. I have reproduced below certain points he has discussed in the article. For a detailed study along with chart examples and a short video on the same can be viewed here. Additional reading on the ADX can be done at Investopedia and at Stockcharts.

J. Welles Wilder developed the Average Directional Index (ADX) to evaluate the strength of a current trend, be it up or down. It's important to determine whether the market is trending or trading (moving sideways), because certain indicators give more useful results depending on the market doing one or the other. The ADX is derived from two other indicators, also developed by Wilder, called the Positive Directional Indicator (sometimes written +DI) and the Negative Directional Indicator (-DI).

Simply put…

• The DI’s and the ADX are displayed on a scale which has a range of 0 – 100.

• When the +DI is above the -DI, a bullish market is implied. It’s vice versa in case of –DI being above the +DI.

• True Directional Movement is the Difference between the +DI (14) and the – DI (14). “The more directional the movement of an index, the greater will be the difference between the DI’s”; in other words, after the DI’s cross and their difference increases they begin to “pull away” from each other (the gap widens), while subsequently, the ADX continues to rise – implying a “trending” market.

• If the price is criss-crossing in a sideways direction, then the gap would be narrowing – implying a “non-trending” market.

• In essence, the ADX is smoothing the action calculated by the DI’s.

The ADX just shows us the strength of the market; it doesn’t tell us the direction of the market. For direction we see the +DI and the –DI. Though merely crossing of the DI’s shouldn’t be taken as an absolute signal, it should be treated as an early warning signal and subjected to the guidelines below:

• If the ADX reading is below 20 or the ADX drops below both DI’s - a “weak trend” or a “non-trending” market is implied. Therefore a “non-trending” system should be used for confirmation, i.e., oscillators, such as MACD or Stochastics.

• When the ADX drops below 10, the current trend is virtually dead. Be ready for the beginning of a new trend – bullish or bearish; the ADX doesn’t distinguish the direction. Use your other indicators to make this decision. However, after a period of consolidation, a “new” trend may resume in the previous direction.

• An ADX reading above 20 implies the “beginning” of a new trend; whereas; a rise above 25 implies a “trending” market.

• IF the ADX rises above the 40 level, the market is even stronger; however…

• If the ADX subsequently drops below the 40 level, it’s an early indication that the market is weakening, which frequently leads to a reversal.

• Subsequently, a turndown at the lower levels (without reaching the 40 line) is generally a retracement or consolidation signal (not a reversal signal). Look for confirmation and trade accordingly.

• After the DI’s cross and their difference increases; in other words, as they begin to “pull away” from each other; better yet, the gap widens, while subsequently, the ADX continues to rise – trending market strength is implied.

• Once the ADX breaks above the +DI and the –DI, a retracement or reversal is on the horizon.

As is it with all the indicators here also the same warning goes that one must always look for conformation from the PRICE!

Everyone loves bull markets. In a bull market, every stock will give us good returns. But bear markets test one's real ability, company's fundamentals and investor's patience levels. But Bear markets also provide wonderful investment opportunities if we can able to spot investment chances early. We can make good money in very short term period.

2 types of investment strategies in bear market: 

1. Accumulate more on every fall and invest for long term to reap full benefits. Even good stocks will be available at cheap prices in bear market due to bad sentiment.

2. Ultra short term opportunities. You should always be on alert to utilise these chances. If you enter late, losses will be more as it happened in case of Orchid chemicals investors who entered into that stock at above 300 levels.

Alert: Operators will try to fool investors by artificially rising stock prices by spreading rumours. Be careful with stocks like Ispat, RNRL, IFCI and Essar Oil. If don't have enough knowledge on Stock Markets, stay away from these things. If you are a long term investor, don't buy major stocks at current levels.

Bear markets- best money making opportunities: 

1. Over reaction: When L&T announced minor losses in Forex derivatives, everyone sold it despite strong fundamentals of the comapny. We should see for such opportunities to enter into those stocks.

2. Sudden options: Orchid chemicals suddenly lost 50% value despite no change in fundamentals. That was due to Bear sterns sell off. We should be always on alert for such chances.

3. Over enthusiasm: Markets over reacted to open offer and acquisition rumours and took stock price to unreasonable 350 levels. Even if Ranbaxy take over Orchids, 250-280 is reasonable price. We will look for short selling opportunities in such instances.

4. Buyback offers: In a bear markets, prices generally do not justify its intrinsic value. So companies try to buy back shares at higher prices. Just see what happened in Sasken Communications. Look for good buy back offers.

5. Never chase operators: If a stock is rising without any reason, simply stay away from such stocks. It is due to operators activities. Never invest in any stock basing on rumours.

6. Crucial breaks: Some decisions will change company fundamentals to much attractive levels. In these instances, stock price will rise for prolonged period as it happened in Bombay Dyeing.

7. Rallies in bear market generally will not last for prolonged periods. So, make money in short term and exit that stock.

8. Short term opportunities will be available in stocks that lost more than 50% in a short period despite good growth. We should identify them early before markets recognise them as it happened in ICSA Indiaand Gujarat NRE Coke.

Investors can't sit idle in bear markets as investors over react to bad news and stocks will lose all the gains in 1-2 days. These ultra short term opportunities are only for experienced investors who can spend enough time on stock market research and at trading terminal. More companies are planning to buy back shares means we are going to get investment chances to make quick money.

These are few rules I am putting in here today. Hopefully I intend to read them daily.

· · Try to keep a current P&L; it’s easier to take losses.

· TRADE; you’re a trader, not an investor; but

· Never trade for trading’s sake; it’s better to do nothing.

· Never trade without a healthy attitude.

· Watch liquidity before trading.

· When there is nothing to do ---- DO NOTHING.

· CONCENTERATE.

· Trade what you see and not what you think (this is a personal favorite).

· The trend is your friend.

· If you are having a good day, read these rules again!

· Always keep track of all your open positions.

· Don’t sweat it, trade it.

· If you are not sure, don’t do it.

· Never trade against the biggies; if anything, trade in front of them.

· Never use hindsight; instead look ahead to the next trade.

· Never say “never” and never say “forever”.

· The tape tells the story.

· Relax when nothing is going on.

· Never listen to opinions; deal only with facts.

· Never fantasize; focus on the next trade.

· Buy rumors, sell news.

· Keep expectations low; the profits will grow.

· Don’t carry mistakes home overnight.

· Be Patient; profits for the whole day (week/month/year) can come from one good trade.

· Never, never average down.

· Recap all trades at the end of the day.

TRADING PLAN

This plan is based on much of what Dr. Elder advocates and I am deeply influenced by his methods. The main idea behind this plan is to trade short term swings. This plan lays emphasis on trading with the trend and has shades of Triple Screen method. We generally start by paying close attention to the external stimuli and market internals to check the undertones of the overall market. Then we use a wide variety of scans, which one is comfortable with to zero in on the scrips worth trading. This plan lays equal stress on strict money management. Though this plan may sound too boring or appear too long but I feel a trading Plan is essential for the survival of a good trader.All care has been taken while devising this plan to embrace the element of KISS! So here it goes;

1. The Market Internals.

Here we tend to look into a few indicators that show the overall breath and underlying strength and weakness of the general market. There are plenty of such indicators that one can use, I am particularly tryin2limit my list to just a few.

A. Vix: Vix is a volatility index. This is based on the activity of option traders. Vix is a contrarian indicator. Any readings above 35 suggest extreme pessimism and used as a buying opportunity. One should book profits when Vix is nearing 18 on its way down.

B. New High New Low Index: This is created with New Highs-New Lows. This is a very important indicator. It signals important turns in the market when it diverges from the Price. One can also use A/D ratio for the same purpose.

C. Open Interest: It pays to monitor Open Interest. Monitor the changes in Open Interest. Keep a tab on the puts and calls. The max Open Interest in particular calls and puts is suggestive of the resistance and support the scrip is likely to encounter. Along with Open Interest keep a watch on the PCR.

2. Scans For Choosing The Stocks To Trade.

There is a wide variety of scans one can choose from; again this is a matter of personal choice. I like to use;

1. Price Volume Breakout
2. MACD Divergence
3. Triple MA Crossovers
4. The Visual Scan (patterns etc); I consider this as the most important!

Whenever you run your scans the list needs to be additionally filtered by running the Relative Strength Comparative (RSC) and ADX filters. The idea behind such filters is that we want to zero on the scrips which are outperforming the Index and are showing strength (RSC). The ADX filters those scrips where the trend is strong and the move will be fast and strong. Again I repeat why we use such filters is that we want to get into the scrips which are ready to move immediately (ADX+25) and are likely to outperform (RSC).

3. Chart Analysis.

Armed with the list of scrips we now move on to Chart Analysis. First on our list is;

1. Monthly Chart. I use Monthly Charts to see the broader trend and some major support and resistance areas.
2. Weekly Chart. This is very important from the point of view of a Swing Trader. Weeklies are the first things we look into. In here we identify important S/R levels. We look at patterns if unfolding and general Pivot Points.
3. Daily Chart: This is used for action. In the daily chart we look for Swing Highs and Swing Lows. We also pay close attentions to the patterns. Judicious use of MA’s and Trend Lines intimate us of future S/R levels.
4. Hourly Chart. This is primarily used for the purpose of fine tuning our entries and exits. For a Swing Trader this particular chart is of no major importance but for the Day Trader this is the most important chart.

Since we are dealing here with the charts, it would be prudent to bring up the topic of indicators to be used. I personally feel the choice of Indicators is a personal one. Use what one is comfortable with. Personally I like to overlay my price pane with 20/50/200 EMA,s. A price Envelope, to identify targets. The Lower panes are occupied with RSI/MACD and Stochastics.

4. ABC Rating.

Once our chart reading is over we yet again rate the charts in the order of their priority. We rate them on scale of ABC. A stands for high probable trade that we our likely to take the very next day. B is for a trade where we think that the trade needs to be worked upon for sometime before initiating an entry into it. C is for the trades where we can see some major patterns unfolding. The trade looks promising but needs time to develop; hence patience is required to let it ripen before we taste the fruit.

5. Taking The Trade.

This is where all the above leads to. Pulling the Trigger. Books have been written about this but I would rather keep it short and sweet. TRADE IN THE DIRECTION OF THE TREND. We only initiate our trade when our Daily Chart is in sync with our Weekly Chart. Anything contrary is sacrilege. After doing all the above exercises we do not want to blow it up by going wrong in pulling the trigger. Even the best of trade setups go awry if we jump too soon. It is said there are three very important rules that can give you the best entry in the world. These rules are Patience, Patience and more Patience! While speaking about taking the trade one of the most important things before initiating the trade is defining of the following; the Entry Price, the Stop Loss, and the Exit price. If you are unsure of any one of these three you are not allowed to enter. The next step after entry is to monitor the trade and take profits when target is achieved. Here if one feels that the target is likely to be overshot then one can use trailing stop. Another golden rule GREED IS GOOD but never ever let your winning trade get into a loss. Love your losses so much that you want to take them as soon as they occur!

6. Money Management.

This pertains to most what Dr. Elder teaches. Never bet more than 2% on a single trade. Never loose more than 6% of your capital in a month. Very simple yet hardest to follow. This is the HOLY GRAIL. If you have mastered this then you are THE MASTER!

7. Organized Trader.

This lead to the finale where all the above ends! Yes the very important part The Documentation. Every trade needs to be carefully documented. Every chart needs to be marked and saved. Every lesson learnt every moment of Glory, every moment of Despair needs to be saved and well documented. This forms the foundation on which you will build your successful trading career.

This is the gist of a good trading plan. This is not a final plan coz there can never be a final plan. We change with times things change there will be changes or rather should be changes in this plan as we move forward in our journey. You need to make a plan that suits you, a trading plan is like a well-fitted suit, every individual has different styles but the basic structure stays the same!!! I am tryin2implemnt my plan, if youhave any further additions or refinements to the above then do let me know.

Mostly the posts are on Nifty behaviour based on Elliott wave principles and some technical indicators mostly the macd(Moving average convergence & divergence)and the tech & Pivot table for trading levels.

A. Elliott wave: Read the simple presentation and a small free tutorial given in "Elliott wave" link under the title "Education-TA/ EW" at the right bottom of my blog.You can learn Elliott waves from "Elliott waves lives on" - Tony's blog from my blog list. He has given very simple presentation. Once you start liking it, then go for "Elliott wave Principle" by Prechter & Frost.

B. Technical Analysis: Read the various studies given in "Swing trade charts", "StockCharts", "Icharts" links under the title "Education-TA/ EW" at the right bottom of my blog.

No:1.
Sector study: Watch everyday either at Bse or Nse for the sectoral index gainer/ losers that tells you of the outperforming sector.This helps to focus on a good stock in that sector to play to get higher returns.
There is also a rotational play among sectors during an uptrend. By keeping a simple watch on the sectoral indices(Bse has more detailed sectoral indices) during mkt hours , our focus remains centered in the thick of the action.

Market Internals: If during an uptrend, one sector starts to turn down/ signal a downtrend...that is internal weakness for you. And it helps to have a cautious approach to the overall market.

Stock to Buy: I use a combination of the following...In an uptrend, after an "abc" correction and during a downtrend, after a 5 wave completion or after a larger "ABC" completion...EW.

2-Day swing reversal..i.e. when the stock goes above two day high, coupled with closing above 5 ema or Dma. Also the macd turning up & triggering the 9 sma line coupled with the stochastics turning up from the bottom.

Best trades are effected after a good positive divergences. Same goes for Negative divergences too. You need to have the patience & calmness of mind to wait for that opportunity and grab it promptly without confusing our mind with the conflicting thoughts that go through after a devastating decline or an euphoric rise. An analogy here would be like the person going for a fishing trip..

Any further upsides left: Except for a "V" shape reversal, other reversals have topping out patterns(Head & Shoulder, double & triple bottoms, candle reversals like evening star, gravestone doji, etc) with negative divergences in larger time scale like weekly.Until that happens, one can book partial profits with daily topping outs and reenter to ride the upmoves till the weekly reversals.

More time you expose yourself to market actions and your willingness & honesty to evaluate your own trading reasons and adapting & changing your approach as it deemed fit with changing situations will eventually make you a better trader because of your level of consciousness improving with more exposure.

A sportsman/woman does not take the sport seriously but plays it with full dedication & application inside the field and gets back to normalcy once the game is over. But a trader keeps on hanging on to that experience for many days even after a new trading day commences.This clouds his/her judgement as well as focus.So develop that sporting attitude.

There is always some uncertainity in trading/ investments but a disciplined and some methodical approach will eliminate a lot of that guesswork. This way, you will come a winner 80% of the time.

Keep studying. applying what you study and raise the level of consciouness to feel "what the mkt is doing" during trading hours.

I will leave you with a blog which I found interesting cos she seems to be applying what she has learnt to good use.
http://www.chartreader.co.in/


No:2.

How to read the Tech & Pivot Table: As you observe the 5day High ema and 5 day low ema, you will observe that when the market is trying to reverse while trading below 5 day low ema, it will first attempt to close above that low ema and then it will attempt the 5 high ema. Once closes above the high ema, the momentum picks up and it will make new highs and stay above this 5 high ema. Once it becomes overbought, it will not be able to continue to make much highs, thereby starts loosing momentum which will reflect in closing below high ema. Depending on the weakness, it will test the low ema.These emas are to be used in conjunction with other technical tools, etc. It gives you an idea of the internal strength or weakness or momentum (up / down) of the market..

As you study it daily, you will find a pattern.

Most Important:-As long as Nifty closes above 5-Ema (That appears just after the close in my table), it is in uptrend & vice versa. At times it gives whipsaws too. Combine all time frames & trade.

Stochastics will indicate overbought above 80 mark.It can stay above 70 in most bullish times.And below 20-30 in most bearish times. Once they reach the top or bottom, expect the macd to turn down or up, followed by Nifty closing below or above the emas..

I try to stay long above 5-ema and short below 5-ema with due consideration to "OB" & "OS" and +ve & -ve readings. That is how simple you can filter it down & play without much complexity.

Whenever a 2 day low or high is broken, the colour changes for the highs/ lows to alert us for a swing trade.

For daily trading, keep the pivot point along with the s1,s2 & R1 , R2.
Combine this with daily Pivot & S & R and "ORB(Opening Range Breakout), you will do well.

No:3.

Market teaches you so much. So keep in touch by doing positional trading and some investing & disinvesting based on "Divergence Play" - one of the most potent way of earning big. A recent example(March.2009) is of the persistent +ve divergences in so many stocks & indices and our mkts refusing to go down in line with world mkts was an indication that weaker hands are in the "Shorts"..So going long and staying invested would have fetched an instant success. Patience....to wait for those opportunities...belief/faith in acting on those observations is the simplest approach.

Let me say this...Get rich slowly and.....quietly.

For excitement, go to a movie in suburban theatres or to a bar or simply walk thru..a crowded mkt place.
With money, play seriously but effortlessly...It is in the mind..Keep it alert to the subtle changes that are developing in the mkt..All the noises should only make you wary of the source...that is the weak hands. Strong money never makes noise but you can detect them in the prices v/s volume & oscillators.


No:4.

Smart traders are those who will patiently wait to initiate the high-probability trade instead of compulsively trade all the time. Market gives you some very perfect trades, if only you are patient.

If you are a disciplined trader and your systems are good, why the low success rate? Ask your self..Are you not following it diligently or letting your emotions/ heresay/ media news, etc to change your views.

Let me give you some tips.
1.Trade the positive divergences to go long in the market. Sometimes it can fail too. And sometimes it may take a while before prices may start to move up. So you can't rush into buy the moment you see a +ve div. Wait for the price to move above 5 day ema/ average.
2. Trade the negative divergences to go short..The rest is same as above.
3.When weekly is down and the daily is turning down from the top(Like the stochastics, macd), sell. But reduce your selling positions once the daily becomes oversold and start to show +ve div..like our mkts now.
4.Play Nifty futures more than the stock futures. And play less of options unless you are sure of the direction and also only in a trending mkt.

These are some of the replies to reader quieries that I am posting here for the benefit of all.