Of all the divergences you can find in the stock market, nothing beats the combination of a reversal bar with an oscillator divergence, i. e. stochastic oscillator divergences for identifying market turning points.
Look what the market is telling us.
If you read the previous section regarding the stochastic indicator, then you know what the criteria are for a buy signal.
Here’s a weekly chart for the Dow Jones Industrial Average for 2002.
Notice that in March of 2002, the market made a higher high than it did when the stochastic oscillator peaked in the first week of the year. The oscillator did not confirm the March 2002 high setting up a divergence between price and oscillator.
The result . the stock market has dropped more than 30% from the spring high to the fall low.
Now what’s going on.
Here we are in the fall of 2002 and look what the market is doing now.
Price has made a new low while the stochastic indicator has not. A divergence between price and the indicator signals a possible buy signal.
What makes this even more powerful is that this week’s bar (as of 11 October 2002) is a reversal bar. For the week, the Dow Jones made (1) a new low, (2) closed greater than it’s open, and (3) closed greater than the previous week’s close. That’s a very powerful reversal signal.
What’s left is to take a position as the market trades above this week’s high, place a sell stop order if it drops below this last week’s low, then manage the trade. The American Exchange “Diamonds” (ticker symbol: DIA) serve as a proxy to the Dow Jones Industrial Average.
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