When going through the timeline last night I came across a post from @AnneMarieTrades that I found interesting:
“Folks, momentum is SLOWING – it dsnt mean we r rolling over. Observe divergence- but don’t trade divergence. Trade price, & price alone $$”
I always like to look for divergences in price with indicators such as the popular MACD, Momentum, or RSI. When I first started trading I read in books that these can be warning signs. So what did I do? Naturally I traded against the trend and in the direction of the divergence that the indicator was pointing to (often at tops calling for downside). Needless to say I lost more money than I made. Sure there were some hits and the psychological feeling was great but I lost more often than I won.
Then I watched a presentation by Linda Bradford Rashke and she stated that when most people trade divergence they fail to look at the higher time frame. This is exactly what I failed to do and needless to say I was usually trading against what was a powerful uptrend. So if you are trading a daily chart and there is a divergence, look at the weekly and what is that telling you? Same goes if you are trading a 5min, look at the 30min; and if you are trading a 30min, look at the 240min or daily. I am quite certain you will be surprised at how often you are trading against the bigger picture. Sure you may catch a top or bottom here or there but those profits will probably go back into the market to the other side. Now divergences are more of an observation than a trade for me.
Posted below is a daily chart with the Momentum Oscillator, MACD, and MACD histogram (difference below the two lines). While many traders like the MACD histogram (bottom pane), I personally do not use it and instead focus on the MACD (middle pane) by putting the Value as a histogram (purple) and the Avg as the line (yellow). If the histogram (purple) is above zero, then it is a bullish signal. Also I will look for divergences on that histogram alone more so than the MACD histogram (bottom pane). Below is a picture of the daily chart of the SPX, note that MACD (purple histogram) has not shown a divergence like the MACD Historgam (bottom pane) has:
Here is the Weekly chart showing the same time frame, highlighted in blue. I left the lines on price to show as a reference to where they were on the daily:
While the daily is showing a divergence, the weekly is showing a powerful uptrend. While many can trade the divergence or scale down to a lower timeframe for day/swing trades then that is great as there can be some homeruns with a good entry and scaling plan. My goal here was to highlight that higher time frame, no matter what time frame you trade on.