Friday, October 7, 2011

A Bullish Divergence in Financials

Now that we are positioned for things to go wrong, what could go right? I have noticed that momentum divergences seem to be forming. A momentum divergence is a technical condition where momentum does not confirm price movement. The chart below shows this divergence by using the Financial Sector SPDR price chart in the top panel and the Relative Strength Indicator in the bottom panel.

The two white lines mark the bullish divergence in the XLF. The price of XLF made a new low on October 3rd; however, the RSI failed to make a new low. This is a sign to traders that a trend change may take place.

However, this is only one small piece of the indicator and a weight of the evidence approach must be utilized. The RSI and price chart are still in clear downtrends from January and the RSI has failed at 50 on every move higher. This suggests to me that the weight of the evidence is still bearish, but that we must continue watching closely. Off the bottom of 2009, financials rose an amazing 140% in 5 months. We don’t want to miss that!