The events of 27 Feb gave us a wake up call and also an answer to a recently asked question. In Trading Tutors #189 (5 January) I started out the year looking at the Dow Jones Industrial Average (INDU) and noted that the chart was starting to indicate some significant divergence when looking at the increase in index prices compared to the decrease in the Elliot Oscillator in Profit Source. Now I want to spend some time looking at this setup because when they come together like this it is most often a case of not if but when one or the other will eventually give in.
Look at Chart 1 below on Pfizer (PFE) towards the start of 2006. The stock price moved up steadily over a three-month period. The jaws of the stock/oscillator divergence were widening at about the same rate. Eventually something had to give and in this case it was the stock price.
Chart 1 â PFE Daily Bar Chart
IBM follows a similar pattern again on Chart 2 below. In this case it was a more rapid pace in which the pattern formed. In fact it only took three months to run up and about the exact same time to run back down again, dropping a massive 25% of the stock price in one fell swoop.
Chart 2 â IBM Daily Bar Chart
Again looking at Chart 3 on the DOW (INDU) you can see that is was a much more gradual climb and the divergence started to kick in around four months ago.
Chart 3 â INDU Daily Bar Chart
Now I am not saying that this is necessarily a sell signal on its own, but learning to use such a setup in combination with other triggers such as a DMI or MACD can be a really effective pattern.
So here are a few examples of stocks setting up with this pattern at the time of writing on March 1. InterActiveCorp (IACI) is a stock shaping up quite nicely. The divergence has been building up over the last four months and at the moment it seems poised for a movement to close the distance.
Chart 4 â IACI Daily Bar Chart
Urban Outfitters (URBN) is another stock to keep an eye on for a similar setup along with Colgate Palmolive (CL). The interesting thing with Colgate is that the stock is right up there and coming back from all time highs in the last week, which gives a higher probability of running down and closing the gap. We saw this with the DOW last week.
Chart 5 â URBN Daily Bar Chart
Chart 6 â CL Daily bar Chart
As always my recommendation is that you take the information from this article as a learning tool. Instead of trading these setups, wait and watch them happen first so you can see for yourself how they work (i.e., paper trade them and watch how these ones pan out over the next few weeks or months.)
Good luck with your trading.