The Handbook of Technical Analysis + Test Bank_ The Practitioner\'s Comprehensive Guide to Technical Analysis ( PDFDrive )

thE hAnDbook of tEchnicAL AnALySiS

where a trader could initiate a short position as price validates the downtrend
line at its third point of contact. At this point, we see the stochastics at over-
bought at time line 3, which is bearish for Gold. We also observe reverse bearish
divergence between the peaks located at time lines 2 and 3, indicating a potential
downside continuation of the current larger trend. In similar fashion, we see
standard and reverse bearish divergence acting as a leading indicator between
points B and E, with the downtrend line providing resistance between C and E.
The stochastics are also all at overbought at these points. This combination of
divergence with other non‐correlated oscillators and overlay indicators together
create high probability entry points for traders interested in establishing short
positions in Gold.

9.3.12 volume bar action, Open interest,

and atr Divergence

The rules for interpreting divergence are markedly different when it comes to vol-
ume bar action, open interest, and average true range (ATR). We cannot employ
terms like standard or reverse divergence. We are only able to describe a setup as
either bullish or bearish and divergent or confi rmatory.
The rules of interpretation are as follows:

■ Rising prices with declining volume bar action represent bearish divergence

■ Rising prices with rising volume bar action represent bullish confi rmation

■ Declining prices with rising volume bar action represent bearish confi rmation

■ Declining prices with declining volume bar action represent bullish divergence

Note that the rules above also apply to the moving average of volume and to
open interest and the ATR. Declining volume or open interest in a rising market is
bearish as it indicates that there is an increasing lack of participation and interest
in seeing prices go higher. Conversely, rising volume in a rising market indicates
increasing interest and participation, which is bullish. Declining volume or open
interest in a falling market is bullish as it indicates that there is an increasing
lack of participation and interest in seeing prices go lower, whereas an increasing
volume would suggest that market participants are interested in seeing price go
lower, which is bearish. It is also important to note that extreme volume in a rising
market may no longer be an indication of bullishness, but rather one of poten-
tially increasing bearishness as the market blows off and heads south in a rapid
decline. The same applies to extreme volume in a falling market.

tip

When it comes to interpreting divergence, and for that matter any other

technical indication, it is wise to remember that as a general rule extreme

bullishness is potentially bearish and extreme bearishness is potentially

bullish.