Trading Divergences

Good morning. Futures are slightly positive as markets react to the latest earnings and data, as well as headlines from Europe. Here are the most important ones for your review:

  • Jobless claims unchanged (MW)
  • EU expects mild recession (BL)
  • European banks take Greek hit after deal (BL)
  • German business confidence at 7-month high (BL)
  • Germany threatens to undermine Greek deal (GU)
  • Greece readies debt swap under bailout deal (REU)
  • Asian firms stampede to raise cash (WSJ)
  • UK and Japan fight Volcker rule (FT)
  • HFT firms face fees on canceled transactions (WSJ)
  • Safeguards planned to prevent MF Global repeat (NYT)
  • New push for reform in China (WSJ)
  • Obama to address gas prices (YF)
  • Home resales at yearly high, supply falls (REU)
  • Million-dollar foreclosures rise (YF)
  • Solar turnaround eclipses by subsidy cuts (WSJ)
  • FDA panel backs Vivus weight loss pill (YF)
  • BATS get closer to going public (WSJ)
  • Web firms agree to adopt no-track button (WSJ)

Much like what we saw on Tuesday afternoon, the market looked and acted exhausted yesterday. A choppy start formed a reversal setup in the morning which took us down to prior range highs at S&P 1355 but still short of the measured move target. After discovering support right at the prior range high and again at the first support pivot (something we were looking for yesterday), we then bounced in the afternoon in a most sloppy, disorienting fashion.

So, what’s my take about this? So far this week the market continues to act tired by consolidating last week’s range breakout and move to new highs on Tuesday. As we all know, the range breakout still remains intact so long as we hold above it which the market did so successfully, although not impressively in yesterday’s trade.

S&P 500: Daily View

I know from my conversations with those who I mentor (and others I very much respect) that many of you are growing nervous and anxious regarding the numerous numerous divergences in play at the moment. For example, many of you I know are looking at the relative weakness of the transports and especially Uncle Russ as signs of a pending correction or trend change.

The primary problem is that while divergences like this can often be useful, their track records as accurate leading tells have been mixed particularly over the last few years. Time and time again, we’ve seen these sell signals run over by the bull camp who remains flushed with liquidity and backed by worldwide government intervention measures on an unprecedented scale and duration. In sum – if you traded these divergences with any level of consistently, you would be shaken out early and often in some very impressive bull runs. If anything, what we’ve seen when these divergences appear is the market to go through a period of consolidation not unlike what we’ve already seen this week.

This is why I, and most of you who I’ve influenced here in a constructive manner, have learned to concentrate on price and the patterns that develop rather than trading divergences. While we certainly are always aware of them and respect their presence, the fact of the matter is that until we see price deterioration confirm what the divergences indicate (they’ll need to do much more damage that we’ve seen so far this week) there is no justification yet for calling a market top or positioning like one is in place.

Sure, that could quickly change and the bear camp could for the first time take a firm grip over this market now as so many expect (lots of gurus are calling for 5% correction now as many have from much lower levels – they’ll be correct eventually), but until we see that the bears have the muscle to do so, the path of least resistance is still higher. For example, if the bears now have control, we should start to see them take full advantage of intraday reversal setups like we saw yesterday morning, but not just be easily stopped and turned around once arriving to the first support pivot intraday. If the bear camp can’t control the intraday price action, then we can’t make the assumption yet that they will take full control over the market.

So with that said, let’s see how the market handles itself again today and whether we continue to hold above the prior range at S&P 1355. Have a great Thursday!

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About abwehra group

The Art&Science of Trading Gold
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