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"You can sell anything short and make money!"

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In the bull market days, there are those that said "you could buy any stock and make money." Perhaps today there are those that say "you could have shorted anything and made money." While there are some truths to these sayings, there are many untruths. Those "untruths" are what we as traders and investors call DIVERGENCE and that's where traders may want to be looking to find some trading opportunities.

Here's a quick technique that traders can use to help start uncovering some potential DIVERGENCES in the market. First, we must all understand that the trend is DOWN so divergence will be opposite of the trend. Considering the shellacking that the broader market averages have taken this is where we would start.

Since the long-term can only start with the short-term, then we have to use some short-term intervals in order to try and uncover potential DIVERGENCE.

Here's similarity. I've often said that I learn more about and profit from divergence than I do similarity. When we look at a chart of the NASDAQ Composite (COMPX) and the Semiconductor Index (SOX.X) you can see the similarity. For the most part, if you're short or long the Semiconductors, you're getting much the same type of action there that is being seen in the NASDAQ. Each trading very much off of each other. Is the dog wagging the tail, or is the tail wagging the dog? We can't answer this and it leaves traders with a 50/50 proposition of guessing market direction.

Stacking of NASDAQ and Semiconductor Index

Notice how similar the above charts look on the 10-minute interval. We're also noting this morning's rally in the NASDAQ Composite to the 1,455 level, which is one of our retracement levels from a fitted retracement. You can almost here the institutional short this morning at the open saying "cover some short positions to 61.8% retracement of 1,455 then stop." Heck, a trader trading the SOX didn't even need to guess where the SOX would find resistance. One could argue the SOX was going to stop its rally when the NASDAQ did.

This kind of action may eventually change however, and then that becomes DIVERGENCE. Right now, both are trading very much in unison. This gives hint that much of the trading taking place is only based on risk management and not really based on some "magic" valuation number that some might be trying to push through the media.

Now DIVERGENCE

Traders that have access to a charting service like q-charts are able to "click" through the major indexes and sectors on various time intervals like that above. As you click through the charts, you note many similarities. Here's a few though that don't look similar. It's divergence and gives first hint that these groups may either be sold out, or at least there doesn't look to be as much aggressive selling taking place.

Stacking of Biotech, Natural Gas and Oil Service

Notice many of the similarities between these three charts, but notice the DIVERGENCE of these charts compared to the NASDAQ Composite (COMPX) and Semiconductor Index (SOX). The above three indexes have been holding their lows back to Wednesday, the 19th. Short-term, these indexes seem to have found better support and may give hint that aggressive sellers are starting to go away short-term.

Much like Sesame Street, we ask "which one of these charts is not like the other? Which one of these charts is just not the same?" It's not a leap to say that the Natural Gas Index (XNG.X) and Oil Service Index (OSX.X) share closer ties than that found with the Biotechnology Index (BTK.X). Perhaps this is why the XNG.X and OSX.X are both trading above their 50-period MA's on the 10- minute intervals. Now, shorter term traders have some type of moving average to begin building from and some type of resemblance to "upward" movement taking place. Yes, very short- term, but you can't get any type of long-term trend unless you start at the short-term.

First critical test of all this? Since the XNG.X is sitting right on its 50-pd MA, then a trader looking for strength here or even in the OSX.X will want to see the XNG.X continue to trade above its 50-pd MA on this 10-minute interval. Should it break below, the trader may then get a heads up to potential weakness in Oil Service stocks. It's quite early, but time to start looking for things like this and uncovering some clues on where we should be looking to trade. A bullish trader wants to try and stack as many odd in their favor as possible.

A bearish trader is looking at all of the above and perhaps thinking. If Oil Service, Natural Gas and Biotech stocks are somewhat stronger than the broader market averages, then I may want to be looking to cover some positions in these groups.

The bullish trader is perhaps using that exact logic or thought process to begin identifying some bullish candidates to the long side.

Ranking!

We could now also begin ranking some sectors. For the most part, we're looking at Oil Service as strongest (its further above its 50-pd MA), then the Natural Gas stocks (right on its 50-pd) and then the Biotechs (under their 50-pd, but holding above 09/21 low).

Jeff Bailey
Senior Market Technician
www.premierinvestor.net

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