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DIVERGENCE INDEX


Market Showing Strong Divergence

06/02/03 10:53:11 AM
by Matt Blackman

The market has been ignoring bad news and celebrating the good. But how long can the good times last without a hangover?

Security:   $OEX
Position:   N/A

Since March 11, the market has been on a tear. Driven by encouraging corporate earnings reports and some good economic data, the bulls have come out of hiding with a vengeance wearing their party hats. Momentum indicators such as the commodity channel index (CCI) and stochastics are glued into overbought territory on the weekly charts of the S&P 500 and the Standard & Poor's Deposits/Receipts (SPY).

But amid the popping corks and clinking glasses, there are growing signs that the good times may be coming to an end, at least temporarily.


As a contrarian indicator, the VIX signals that the market is getting ready to correct with values in the mid to low 20s. Values approaching 50 have historically signaled market bottoms. As Figure 1 shows, both the OEX and VIX portend a change in direction.



Figure 1 – Daily charts of S&P100 (OEX) and CBOT Market Volatility Index (VIX) both showing strong bearish divergence with the %D divergence and signal line divergence indicators. Indicators by TradingAlchemy.com
Graphic provided by: TradeStation.
 
The weakness with divergences is that because signals are based on momentum indicators (which can remain overbought in uptrends and oversold in downtrends), it is imperative that they be confirmed by trend analysis. This means that a sell signal should not be acted upon until the trendline is significantly broken.

It is also interesting to note that we have hit the critical 965 level on the S&P 500 index (Figure 2), which is the neckline of the long-term head & shoulders top pattern (see The Critical Head & Shoulders Test - Working Money, 11/12/02). Technicians will be watching the market closely for signs that the resistance level will hold or break.


Figure 2: Weekly chart of the S&P

Another red flag is the number of insiders selling versus buying, especially in the tech sector. According to the Wall Street Journal, most recent insider share transaction figures (week ending May 13) show that insiders sold 815.8 million shares to 27.8 purchased for the week. Insiders also announced plans to sell another 867 million shares in SEC filings. Including both current and planned sales, that's a ratio of more than 60 to 1.

Do the insiders know something we don't?

Suggested Reading:

Blackman, Matt [2002] The Critical Head & Shoulders Test, Working Money: November



Matt Blackman

Matt Blackman is a full-time technical and financial writer and trader. He produces corporate and financial newsletters, and assists clients in getting published in the mainstream media. He is the host of TradeSystemGuru.com. Matt has earned the Chartered Market Technician (CMT) designation. Find out what stocks and futures Matt is watching on Twitter at www.twitter.com/RatioTrade

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Comments

Date: 06/02/03Rank: 5Comment: 
Date: 06/03/03Rank: 5Comment: Yes, this Article, and so many others, are great ( comforting to see technicals that I hadn t checked out, backing up my own thoughts.) Pointer, thought: Could you please get your authors to NOT submit Charts with background colors (black!) These look pretty, but printing the article sure takes a heck of a lot of ink--and those ink cartridges are never reeuced in a sale! Thanks, B. H. Peterson
Date: 06/04/03Rank: 4Comment: 
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