Do Negative Divergences Matter?

I got back yesterday from a 5-day vacation to Colorado.  What a beautiful state.  Still can’t believe that I can leave the door completely open with no screen and enjoy the breeze with no bugs and no humidity to interrupt dinner.  It was nice for once to take a vacation and not really worry about the market.  I arrived in Colorado Springs on Thursday evening.  I was on the golf course early Friday morning and I tried my hardest to not look at the market.  Even though I wasn’t worried about it, I had to still check it.  Technology got the best of me.  I had my Bloomberg machine on my phone right there on the golf course.  Between horrible shots, I checked my phone only to see the market moving higher.  I was sitting there on hole #2 when I read that Ben Bernanke said “economic activity appears to be leveling out, both in the United States and abroad.”   He also said “prospects for a return to growth in the near term appear good”.  I had to laugh.  I’m glad he’s finally acknowledging what I’ve been writing about and talking about on my radio show for a few months.    The economy is getting better and the stock market is reflecting that.  That’s why we continue to rise.  Persistent buying.  This is the complete opposite of the fall of 2008 sell off where every day there was persistent selling because investors wanted to reduce risk.  Now, they are assuming more risk.

Remember last Monday when it looked as if the market was going to roll over?  We opened down 2%.  China was weaker, consumer confidence was weaker.   But, that bad day was followed by 5 straight days of gains.  I’ve been preaching for a few weeks that we need to give stocks more room to move.  In other words, put up with more volatility.  Last Monday was a perfect example.  A few months ago, I wrote about the bully in school that would flinch.  When he flinched, you’d better duck because one of those times, he might just take a swing at you.  That was then and this is now.  Now, I’d say when he flinches, don’t move.  The summer has come and gone and now you’re bigger and stronger.  He might hit you but it’s not going to hurt.  When he flinches, relax.  I’m suggesting moving out your time frame a little bit.  If you’re looking a osicllators to trade from, use a larger number.  If you’re using stop losses (which I’m not), use a longer moving average.  This would have saved you from selling last week and having to buy back in at higher prices or better yet sitting out right now while the market moves higher.

Given the economic backdrop, I still believe we have another 15-20% left in the averages over the next few months.  I’m not sure it’ll be in a straight line or not.  In fact, I’m starting to see some negative divergences building for the first time in a while. You can see below, I’ve got a picture of the S&P 500 (SPY).  On top of the price, I’ve got the RSI indicator.  It’s been going down while the price of SPY has been making new highs.  This is a negative divergence.  Just one, but it’s something to watch.

spy 082509

Now, this isn’t the first red flag we’ve had since March.  There have been others.  In fact, I have people telling about Elliott Wave patterns and that we’re at a critical level.  I’m not dismissing all the technicals.  But, using anything other than the economic improvement in the past few months hasn’t been as profitable as plain old fundamentals.  There are a ton of traders that are either short or not invested right now.  They’re frustrated and confused.  As I’ve said before, that means there’s plenty of cash on the sidelines ready to come in.  It’s the ammunition to move us higher.

I’m watching these technical divergences just like I always have but as long as the internals remain strong and the economy continues to improve, I’m slowing down my day to day trading and focusing on the medium term (the next few months).  That doesn’t mean I won’t hedge from time to time if I really think we’ll have a reasonable correction similar to the June correction.  But, for the most part, I’m still playing it from the long side.

This post published at www.karleggerss.com

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2 Responses to “Do Negative Divergences Matter?”


  1. 1 Ed Janes August 26, 2009 at 9:12 am

    I wonder if we are in another sideway consolidation?

    • 2 keggerss August 26, 2009 at 10:02 am

      Ed,

      Good point. Nobody ever discusses that. They either think it’s going up or down. Remember, in a bull market, a sideways move is the correction. Sometimes, that’s all you get. It’s very possible that is the outcome for a while. I wouldn’t mind that. The bulls are bears seem fairly equal at this point. So, it makes sense we could see that sideways action you mentioned.


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