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Trader's Corner

Keltner-Style Divergences

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Over the last few weeks, we've been studying the advance/decline (A/D) line. We've used nested Keltner channels to make determinations about what might happen with the A/D line.

Some market watchers, including me, think that volume patterns tend to lead price action. The hope is that by determining where the A/D line is likely to go and when it might turn, we might predict or at least corroborate what the SPX is likely to do.

Previous articles in this series have explored whether it's appropriate to study the A/D line using technical analysis tools, where to look for resistance or support for the A/D line, and how to judge whether support or resistance is strongest. Last week's article discussed setting targets for the A/D line. If you haven't read those articles or are unfamiliar with the A/D line or Keltner channels, a quick review might be appropriate.

Nested Keltner channels possess one last quirk that might help traders judge what's going to happen next. They display Keltner-style divergence.

People can get downright angry when determining what constitutes bearish or bullish divergence. We have an advantage here. Not many people discuss nested Keltner channels at all, and almost no one discusses Keltner-style bullish and bearish divergences. No one is going to argue with us.

I look for any divergences in Keltner channel setups or the way prices react to those setups at recent highs as signs of bearish divergences and any differences at recent lows as signs of bullish divergences.

To best illustrate what I mean, let's look at an example from the SPX's daily chart.

Annotated Daily Chart of the SPX:

Annotated Daily Chart of the SPX:

My intraday charts cover only a 10-day span, so I drew from those daily SPX charts to find more examples of Keltner-style divergences. Now that we've seen Keltner-style divergences at work on the SPX's daily chart, let's look for instances on the A/D line's intraday charts.

Annotated 30-Minute Chart of the A/D Line:

Perhaps you're thinking that the same kind of information could have been derived from the SPX's chart alone. Not necessarily. For example, look at the same period covered in the A/D chart immediately above, this time studying an SPX chart.

Annotated 30-Minute Chart of the SPX:

In this last instance, Keltner-style divergence on the A/D line was showing a possibility that the SPX might climb, but the SPX charts weren't yet showing those same Keltner-style divergences. The A/D's chart was leading in this instance. The A/D line was providing a heads-up to traders.

As with any style of divergence, however--bullish or bearish, derived from price/oscillator comparisons or Keltner charts--a heads-up is all you're getting. You're not getting proof. Such divergences provide you with time to begin making your what-if plans. What if the A/D line is about to reverse? Where would it likely go if it did? What kind of profit-protecting plans need to be made for my trades? As with any kind of divergence, make those plans but let price action be your determinate of when those plans need to be put into action.

Next week, we're on to something else. About time, some of you might be thinking, but whether your agree with the information in this series of articles or think it's all hogwash, I urge you to watch the A/D line.

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