Divergence Analysis
fairly correlated oscillators, that is, the relative strength index (RSI), MACD,
and commodity channel index (CCI) accompanying price, rendering the ap-
parent agreement between them somewhat less credible, with the potential of
misleading the trader or analyst into a false sense of confidence. Since all are
constructed around price, these oscillators tend to give similar signals much of
the time. We say that the oscillators are collinear. It is best to choose oscillators
and indicators that provide a greater degree of independent signaling.
If a longer‐term trend was originally to the downside prior to the diver-
gence setup, then this bearish setup is expected to lead to the resumption of
that original prior larger trend, recognized also as a continuation at the second
higher wave degree. In Figure 9.38, we see the price continuation violating
point 1, which confirms the subsequent larger downtrend, and in the process
establishing a downside continuation of a trend at the second higher wave
degree, that is, one wave degree higher than the subsequent larger trend.- Bear Setups occurs when only price, and not the supporting data series, is mak-
ing equal or higher troughs. Price is expected to initially continue to make high-
er troughs and peaks until a top is formed, thereafter reversing to resume the
subsequent downtrend at the next higher wave degree. The rationale behind
the bearishness is as follows: falling troughs in the supporting data series indi-
cate diminishing momentum, which reflects underlying weakness in price, and
therefore is potentially bearish for price. Price eventually follows through in the
direction indicated by the supporting data series at non‐confirmation after a
short upside continuation of the current larger trend. See Figure 9.39.
In Figure 9.40, we see a bear setup between points A and B on IYT (iShares
DJ Transportation Average Index Fund, NYSE). Using channel projection
techniques based on trendline TL1, we identify a potential top in the market,
after which price confirmation of the bear setup in the form of either the viola-
tion of the uptrend line TL2 at point F or 20‐day exponential moving average
Figure 9.38 Reverse Bearish Divergence as Continuation at Second Higher Wave Degree.