For what seems like months I have been writing about the divergence between the price of the VectorVest Composite and the proprietary VectorVest MTI indicator. The MTI is a momentum indicator based on the combined rate of change of both the price and breadth of the Composite. The breadth is measured each and every day by calculating the number of shares on a VectorVest BUY recommendation divided by those of a sell. The metric is known as the BUY/SELL ratio and it’s an important part of the various VectorVest Market Timing systems.
The divergence started in Mid-August 2016 but could only be labelled as a divergence from the first week of October. In the first week of October the Composite made a new high but the MTI charted a falling high. This is known as bearish normal divergence. As its name suggests the pattern is an advance warning of a change in trend.
The chart of the UK Composite is shown below and the divergence is clearly marked. However there are many other interesting facets to the chart which also pointed out the rout of the last week, well in advance. I have written about them all in the column over the past month.
To start with, the mirror image of the bearish normal divergence of the last month occurred in February this year. As the market collapsed into the middle of February the Composite charted a new low while the MTI could not follow and charted a rising low. This is known as bullish normal divergence and it preceded the upward move in the UK market which has been in place for most of this year. Divergences are leading indicators of change. I have spent many years studying their nuances and there are many. Bullish signals from price which are preceded by bullish divergence have in my view extra validity as was the case when the Confirmed UP signal fired at the end of February 2016.
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During the last week the most conservative bearish signal on VectorVest fired and similarly a bearish signal from price which is preceded by bearish divergence should be taken very seriously by all.
On the chart of the UK Composite I have marked a “rising wedge” pattern. This pattern goes by many names. The Elliott people refer to the pattern as a “diagonal triangle” while harmonic pattern traders call it a “three drives pattern”. Some refer to the pattern as “three little Indians”.
In essence the market charts 5 waves from a major low while the trend lines defining support and resistance within the pattern are converging. It a very bearish pattern and normally leads to a strong reversal. I have traded the pattern on all timeframes and in all asset classes. From the low in January the 5 major waves upwards are fairly easy to see. In the seminars when I see faces contorting in a vain effort to observe the patterns I lighten the atmosphere by relating “the first ten years are the worst”. That’s certainly the case in anything Elliott related.
Over the past few weeks I stated over and over again that when the market broke the trendline defining the lows of the pattern that the technical picture would have deteriorated significantly.
If you can observe the five waves upwards, from the low in February, please assign them numbers from 1 to 5.
1 is the low of the middle of February and 5 is the high of a few weeks ago. 2 is the Brexit low and 3 the high in the first week of August. 4 is the low of the 13th of September.
I have noted over the years that a trendline drawn from 1 to 4 determines a target for the pattern. It’s my own observation but the target has proved exceptionally accurate over the years. I once vowed that I would never ever give the construction away to the public but as I get the wrong side of 60 it seems to matter much less. I have drawn the line on the chart and as you can see the target was met on Friday. This is also the case on the Ft100. Does this mean that the market cannot fall further? It certainly does not, but it does mean that the pattern has shot its bolt in terms of predicting the future. The market is now very oversold and technically it should bounce very soon. Only a major news event would cause a further fall without a rally. I think you would agree that there is scope for such an event on November the 8th.
I have expanded the chart of the Composite to show the detail of the past three months and removed the MTI to allow the price action to be more clearly viewed. On this chart there is a classic harmonic pattern known by traders versed in this art as a “butterfly”. The pattern is defined by a fall and then a 3 wave pattern to a new high. The fall between August 15th to September 12 is the wave down which is followed by a three wave pattern to the high of the 11th of October. Harmonic traders refer to this as an AB=CD pattern. In the pattern wave AB is the same size in points as BC. What really alerted my attention was the fact that the high made on the 11th October (annual high) was a 1.27 extension of the selloff prior to the AB=CD rally. The high of 11th October was the perfect place for harmonic traders to short the market and I assure you there are lots of the breed around.
As the market fell from the 11th of October the entire gamut of VectorVest signals have fired in a near perfect order. I have stated the signals here many times. The Primary Wave turned to down on October 26th. This was followed by a red light in the Color Guard and the red light featured a black star within the red. This means that price is falling and the momentum of price was also falling. This occurred on the October 31st and it is a very powerful signal. The DEW technique gave a sell signal on the 1st of November and finally the Confirmed Down kicked in on the 3rd of November. All of these signals are objective and require no subjective input. I believe (and thus it’s true for me) that these signals become much more accurate when preceded by MTI normal divergence.
I cannot decide which of the Market Timing systems that you should follow. That needs though by each trader/investor. It needs to part of a written trading plan.
On the 31st after the red light sell which was confirmed by the RT Kicker trading system (momentum falling) I raised cash by exiting some of my positions. I go into the USA elections only 40% invested. I am holding JD Sports, Trifast, Hastings and Cranswick.
I have a shopping list ready should the market give some green lights over the next week.
Please spend some time on recognizing divergences.
November 5th 2016
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