Rethinking bearish divergences

"Two roads diverged in a wood and I... I followed price... because that's what is most important."  -David Keller

So I posted this recently on Twitter (follow me here)...

"Bearish divergence on weekly $SPX.  Also a bearish divergence on weekly $SPX three other times in the last five years, none of which worked."

I included this chart in the post:

 Source: Optuma

Source: Optuma

I'd noticed the RSI bearish divergence on the weekly SPX chart.  But I immediately thought of a number of times in the last couple years where a similar "oh no there's a divergence" call could have been made, only to see the market continue higher soon after.

An astute Twitter denizen asked the question "how do you define 'worked'"- which is a fair point.  For me, a bearish divergence is something that compels you to add it to a watch list, not something that compels you to take direction.

I bucket an RSI divergence with things like breadth signals, money flow, the Hindenburg Omen, etc.  Not something that suggests you change an active bet, but it's something you monitor closely then confirm with some other technique.

Price is king.

When I teach technical analysis, one of the *last* things we add to our "technical analysis checklist" is "Confirmation", where we include things like volume and any indicators derived from price.  RSI, MACD, etc.

The first thing on the list?  Price.  Don't do anything until you can define whether something is in an uptrend, a downtrend, or a sideways trend.  Then you get fancy with other techniques.

So the answer to the question "how do you define 'worked'?" would be "when the price confirmed the divergence by violating a key support level and following through."

Where does that leave us?

Looking left on the chart, there are three key short-term support levels, colored yellow, orange and red below:

Source: stockcharts.com

The most important is the red line around 2320, which is the clear support level on the weekly SPX chart.  By my read, as long as we stay above that level, the SPX is in an uptrend, regardless of what divergences you see out there.

RR#6,
Dave

Disclaimer: This blog is for educational purposes only, and should not be construed as financial advice.  Please see the Disclaimer page for full details.