The Divergence and Failure Swing

Chart for this article can be found by clicking on "My Yahoo Group Site" under the files section.
File name Charts for Article 6.doc

As you may have surmised, I use only the price chart and the MACD when searching for potential trades. In essence I look for 2 things; a divergence combined with a failure swing.

A divergence occurs when price moves in a different direction then the MACD. In figure 1 of the attached file, notice that price of the NASDAQ Index reached a lower low at point B then it previous had at point A. This occurred while the MACD, at corresponding point 1, is higher then it was at corresponding point 2. After this divergence between the MACD and price, the Index moved sharply higher. Bear in mind that this alone would not prompt me to put on a trade.

Normally the term Failure Swing is associated with the Relative Strength Index. For this study I will use the term to define a very specific pattern associated with the MACD. A failure swing occurs when price action forms a reversal pattern while the MACD diverges AND the “fast line” (green line) remains below the “signal line” (white line). Again refer to figure 1, notice the double top which was formed at points C and D. Now look at the MACD in the lower window. Not only did the MACD diverge from price action at corresponding points 3 and 4, it also revealed a “Failure Swing”.

There is one last step I take before I put on the trade; I consult the longer time frames. The chart in figure 1 is a daily chart. Figure 2 is a weekly price chart and figure 3 is a monthly price chart. Notice in Figure 2 at the right hand edge of the chart, the MACD has started to flatten slightly. This provided further support for the trade.

The monthly price chart in figure 3 provides the primary foundation for the trade. The MACD at the far right edge of the chart is moving lower. In addition, it is also leading the price lower. In a later article I will discuss the term “leading the price lower or higher”.

We have now created the most basic framework for my trading style. From this point forward most of my articles will use price chart examples to explore the more detailed intricacies of trading.

Call or email with any questions,

Bob

PS; After reviewing the copied charts, I see that it is difficult to see the MACD flattening in figure 2. To show this more clearly I have added figure 4 which contains the MACD Osc (histogram). Here we can see that the MACD momentum is slowing. Remember from the article titled Introduction to the MACD, the histogram shows a bar graph representation of the distance between the 2 lines.