Friday, August 13, 2010

Predictive Power

Challenged by DrStock I am touching another subject today, what indicator or oscillator has a predictive power since as we know they are all lagging, they give us a buy or a sell signal after a top or a bottom has already formed not before. The questions is, there is such an indicator that can tell us in advance in what direction is the marker going to march? I am not aware of any such indicator but DrStock has promised to reveal the secret in the next few days so you better watch his website.

What I know is that you can use o positive or a negative divergence in certain indicators as a tool to anticipate the next move. Most of the time indicators are trending in the same direction as the underlying stock. However, sometimes they move in different directions, they diverge. A negative divergence occurs when the stock is moving up but the indicator is trending down. This is a sign that the stock is going to move down soon.  A positive divergence happens when the stock is moving down but the indicator is trending up. This is a sign that the stock is going to move up soon.

Look as SPX since last August. I pull out two indicators, MACD histogram and Elliott's Wave histogram but you can also use RSI and probably many others, such as OBV (On Balance Volume). As with anything else these indicators are never 100% accurate (not even close), so don't expect them to give you an exact buy or sell signal but combined with other indicators (e.g. DMI) and EMAs crossing they may prove useful. Interestingly enough, combining the power of the two of them (MACD and EW histograms) the performance improves.

N = negative divergence
P = positive divergence



Happy trading!

babaro

P.S. A trading book I would recommend is Technical Analysis: The Complete Resource for Financial Market Technicians

4 comments:

  1. Thanks for your insights. If you don't mind, I think I'll interact with this post... because I have a few questions regarding this area I'm less familiar with than you. First, at what point do you believe these indicators signal to an investor they should buy or sell (at the 0 mark or when the positive divergence begins to show or...)? Second, would you mind defining "soon" when you indicate "A positive divergence happens when the stock is moving down but the indicator is trending up. This is a sign that the stock is going to move up soon"? Have you found a ratio between uptrend based on the previous downtrend?

    Thanks... I appreciate you diving into this area. I look forward to learning the benefits of this possible tool in future posts!

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  2. Monday could be a black monday...

    within next 3 months all new relative lows widely beaten..all new absolute lows within 15-19 months.

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  3. WE'll see 9999 very soon...and this time we'll head towards 8000.

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  4. Very interesting questions, indeed. I am not too much into anticipating the market but more into reacting to its moves. I like to peak at MACD or EW histograms from time to time but I do react when EMA50 is crossing EMA100 on 30 minutes charts, this my major timing strategy that served me well in the past. EMAs crossing is not perfect, I am getting whip-sawed from time to time, especially when market is trading in range. However, if the change is direction was anticipated by a positive or a negative divergence in MACD or EW histograms then is less likely to get whip-sawed.

    What I meant my "soon"? A matter of days. You need at least two highs on your histogram to draw a trend. I would say as soon as you spotted the negative divergence and see the histogram going down you should get short. You can wait until it crosses the zero point but by then other indicators (DMI, EMAs) are probably going to give you a sell signal.

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