Divergences?

This is the time when we look for divergences. There are many ways to look at divergences and the approach should always be a weight-of-the-evidence kind of thing. It’s not binary. You simply want to see if there are enough indications that the odds have been tweaked in favor of a reversal.

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The classic divergence is when, in the re-test of a hard decline, price undercuts the previous low but other indicators don’t exceed the levels reached on the day of the first decline. If there are enough such divergences, the odds of a rebound improve significantly.

More often than not, though, the picture is somewhat muddied. And that’s the case here. A few indicators do show divergence, but one important one doesn’t.

Here they are:

First, I’m posting a chart of the SPY. I’m using SPY instead of futures so we can also get a clean read on volume.

You can see that today the October 11th low in price was undercut. But you can also see that it did so on lower volume. That’s one divergence.

Another common divergence go-to is the 52-week new low list. You want to see the new lows contract relative to the first low.

Here, you can clearly see that new lows expanded a fair amount today relative to October 11th, so no divergence.

Another common indicator is, of course, the VIX. You want to see it make a lower high.

You can see that here, the VIX did make a lower high, so we have another indicator suggesting the selling pressure today was less intense.

I also like to look at the number of declining names in the NYSE (common stocks only), which you also want to see contract.

And here we have another divergence. Today’s 2,574 is lower than last week’s 3,209.

Lastly, even though I don’t place too much emphasis on relative strength indices, the RSI on the SPY did make a higher low today, which constitutes another divergence.

Bottom line: We do have a number of divergences. The odds of a rebound are decent. It would be a lot better if new 52-week lows also contracted, but still, decent.

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