Monday, January 7, 2013

Indicator Divergences in the Nifty

Shreyas Nevatia sent me an email saying:
I am an avid reader of your blog and advice on In Nifty daily chart, there is divergence on RSI indicator. Please give your views

 My Notes: Indicator divergences are not meaningful trading signals. They have to be taken in context of price action. A bearish divergence comes when prices are making higher highs and RSI (in this case) is making lower highs. A number of thoughts come up.

How can higher highs be bearish?
What is closer to the market: Price or a mathematically calculated number?
Are we looking at the same chart - same indicator with similar lookback periods?
Assuming that a divergence leads to lower prices, then the question is: for how many days? On my chart with a 14 period RSI plotted on end of day data, there was a clear bearish divergence that was identified on December 20, 12. The next day, prices fell to 5830, which was a low of the two day correction. From this low, the Nifty has rallied about 200 points.

This probably tells you that I am not a fan of divergences. Prices are the best guide for me.

But, I am grateful to Shreyas for raising a relevant question of theory. I enjoy answering such questions.


Dinesh said...

Dear Sir,
What I understand based on my limited knowledge and experience - there is a time lag between the actual event and the time it is reflected & confirmed on the charts. The reading on the chart should be confirmed with various other activities happening or deriving the reading on the chart.
I think it is like X-Ray, MRI or blood test. The pathologist will look at the result and give his/her opinion but the Doctor will look at the result and co-relate with various other factors examining the patient and give the final verdict either considering or ignoring sudden variations.

sometimesbullsometimesbear said...

I like the pathologist/physician analogy. Physicians look at multiple test indicators to explain the symptoms. Financial astro can also be one of the tests.

An interesting financial-astro-scientific analysis i read in this article with proven back tests:

The gist is that right from Jupiter's transit in Taurus from May 2012 to May 2013 the larger trend status quo will be maintained with smaller intermediate blips against this larger trend.

Avinash Ramanna said...

Hi Sudharshan,

I have a system, i just wanted you to review my trading system. This system doesnt use any indicators. Its based on the fact that nifty moves up or down by more than 8% in a span of three months. I took the historical data from 2002 to 2012 did some research. in 114 months nifty went up or down by more than 8% in three. So I made a program to validate this. So I kept the take profit at 8% and I open the trade on the beginning of the month. I take a postion up or down based on the sentiment. For example

say if nifty opens high on the start of the month and it is at 5888 then I take a long position, if the opening price next goes below 5888 then I reverse the position. So I keep doing it until market makes a move and hits the 8% up or down. Here I control the lot size based on a money management formula. So increase the lost size based on the loss incurred in the trade. I did both forward and back testing I see amazing results.

Whats is your view on a system like this? Is there any flaw, have I overlooked any mistake?

sometimesbullsometimesbear said...

Hi Avinash great R&D.

Dinesh Rishi said...

Price Bhujaye Pyas baki sab bakwas

all indicators are made from price, so why not follow price :D

Rakesh Shethia said...

RSI failing to mark higher highs with the price shows that the speed of price rise is slowed down. or is it? the price can move down and thus a valid divergent signal. But if I have to anywhich ways follow the price, whats the need for an RSI. Its just an indicator of getting cautious.

On second thoughts, if the speed of price rise has slowed down, i.e. momentum has slowed, do I still need to be in the lazy price moving stock or do i exit straightaway? if yes, how long?

Rajveer said...

Dear Shreyas, please remember that it is useful to follow only trend following indicators like MACD, ADX for trading trending market. Since we are already in bull market, RSI and stochastics will give u whipsaws. RSI is useful at the top and bottom of the trading range.