Thursday, December 11, 2008

Short Term Outlook

Figure 1 is a daily chart of the QQQQ. The indicator in the lower panel is a short term composite oscillator constructed from the following data series: $VXN, put call ratio, NASDAQ advancing and declining issues, and NASDAQ up volume and total volume. Extremes in each data series are sought, and the indicator oscillates between overbought and oversold.

Figure 1. Short Term Indicator/ QQQQ

The indicator is now diverging negatively from price. In other words, price has moved higher while the indicator has moved lower. The negative divergence bars are noted by the red markers on the price chart.

What is the significance of negative divergence bars? Negative divergences generally indicate slowing upward price momentum, and this is exactly what has happened as prices ran into resistance levels as determined by our key levels. See article from December 8, 2008, "Key Price Levels To Watch".

Backtesting shows that negative divergences will generally define a price range with the lows of the divergence bar defining the bottom of the range and the highs of the divergence defining the top of the range. A close below a negative divergence bar, when that divergence bar is below the 200 day moving average, generally portends lower prices. {This used to be one of the exits for shorter term swing strategies I used to trade.}

The positive, if there is any from today's market down draft, is that the gap has been filled from Monday's open.

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