A word on divergence:

A few posts ago I described the sudden and sharp decline in the Dow from the late July price peak through to early August to be a final Elliott “C” down wave. At this time investor temperament changed from bullish to bearish causing investors to stampede out of risky assets and into safe assets. Now after a late August advance and a September swoon, we found most of the major North American stock indices once again sitting at or just below their relative early August lows. The question was; do we hold, or do we fold?

What I look for technically during difficult times like this is divergence.

Divergence is a condition that occurs when two lines on a chart move in opposite directions vertically. A technician will traditionally look for divergence between a stock's direction relative to the direction of a technical study such as an oscillator or the MACD.

Divergence can also be observed when doing inter-market studies such as gold vs. the gold stocks, a large cap index vs. a small cap index or price vs. volume. There are two kinds of divergences: positive and negative which can be also described as a bull or bear setup.

Our chart today is the daily closes of the Dow Jones Industrials plotted above the daily closes of the US 10-yr T-Bonds spanning about 5-months. In this example I am comparing the Dow to investor fear as illustrated by the flight into U.S. Treasuries. Note the recent prices relative to their August lows. Last September 22, the 10-yr yield closed below the August 8 low and Dow Industrials closed above the August 8 low. This price divergence has created a bull setup because while investor fear was greater (lower bond yields) the Dow price was higher. This is bullish divergence.