Sometimes a technical indicator will disagree or even seem to “fight” with the actual price action of the stock or index you are analyzing. These “disagreements” are actually very useful for technical traders. In part two of this series we will look at the bullish version of these disagreements or divergences.

As you will see in the CCI Video, a divergence appears when an oscilating technical indicator (in this case the CCI) begins to establish a trend that disagrees with the actual price movement. For example, in the chart below you can see the the Gold ETF (GLD) forming slightly lower lows in April. This is representative of a market that is becoming more bearish. However, the CCI technical indicator I have applied is showing a series of higher lows, which is indicative of an improving trend.

For GLD shorts, this is a warning that risk control is going to become much more important because there is a high probability that the trend will be disrupted in the short term. For more speculative traders looking to get long GLD or buy call options this bullish divergence is an alert that a change in the trend may be emerging.

When looking for divergence patterns it is helpful to trade with the prevailing trend and/or a breakout from a consolidation level. As you can see in the chart above both conditions were true. Gold had been trending up since the prior year and the market was consolidating in a descending wedge (usually a bullish pattern.)

Traders use oscillating technical indicators like the CCI because they filter a lot of the noise within the price action. In addition, oscillators are typically designed to show a trader when prices have reached extremes and a reversal is likely, which makes them ideal for divergence analysis.

Click here to see part one of this series.

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