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Trader's Corner

Keltner-Style Divergence

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Technical traders often learn to recognize price/oscillator divergence early in their trading careers. Reading any given website devoted to technical analysis turns up mentions of price/MACD or price/RSI divergence. Nested Keltner channels also display a form of divergence.

Note: Those new to nested Keltner channel analysis might review articles in the Sunday, March 20 and Sunday, May 1 Traders Corner articles for background information and chart settings.

Annotated Daily Chart of the OEX:

Prices produced bearish divergence when the blue channel could not pierce the black channel on last spring's approach. Price action proved weaker in this respect. This proved true even though a close study of the price action reveals that prices moved higher in March than they did in December. Relative to the positioning of the Keltner channels, however, price action proved weaker. In this case, the action also produced bearish price/MACD divergence, corroborating the Keltner-style bearish divergence, but regular price/oscillator divergence does not always accompany Keltner-style divergence.

Another form of Keltner divergence can be discovered on the above chart. Note that when the blue channel was retesting the upper black channel boundary in February and March, that black channel was farther away from the purple channel line than it had been on a similar test in December. That's divergence, too.

Intuitively, these divergences hint that the OEX was not as strong on the second attack of the top black channel line as it had been on the first attack of that channel line. Indeed, the second attack marked a swing high.

Annotated Daily Chart of the OEX:

A higher price high on the second swing high or test of Keltner channel lines isn't required for Keltner-style bearish divergence.

Annotated Three-Minute Chart of the SOX:

As has been apparent from the choice of different time frames for these charts, bearish divergences can be produced on a chart of any time interval. Of course, greater significance can be attributed to bearish divergence showing up on a longer-term chart than on a shorter-term one. Traders should tailor the time intervals watched to a preferred style of trading. Scalpers will watch shorter-term charts while swing or position traders will lengthen the time intervals watched. Even swing or position traders can tailor entries or exits by watching for these divergences on shorter-term charts, however.

Just as is true of other types of divergences, bearish divergences occur at swing highs while bullish ones occur at swing lows. Nested Keltner channels can also produce bullish divergences, as they do in the following chart.

Annotated Three-Minute Chart of the ES Contract

No bullish price/MACD divergence existed to show that prices might be more likely to move up toward the top black channel line than drop again to the bottom black channel line. Keltner-style bullish divergence was the only sign that might happen as prices coiled.

As with all types of divergence, whether signaled by nested Keltner channels or price/oscillator differences, divergences warn that a thrust might be losing momentum. They tell traders to pay attention. If the trend remains a strong one, that divergence can be resolved by sideways price movement, so an immediate reversal cannot be assumed. Sometimes, despite divergence, the original movement resumes.

Annotated 60-Minute Chart of the TRAN:

On this chart, the TRAN's price action failed to follow through on the clear Keltner-style bullish divergence. Traders should not act blind faith, on Keltner-style divergences alone, any more than they should with other types of divergence. However, the warning provided by Keltner-style divergences offers an opportunity to make exit or entry plans ahead of a reversal if one is to occur. Those traders employing nested Keltner channels will find this another useful tool.
 

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