Sentiment in the Forex Market: Indicators and Strategies to Profit from Crowd Behavior and Market Extremes

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c06 JWBK195-Saettele June 5, 2008 19:35 Printer: Yet to come

The Power of Technical Indicators 123

1.3666 in four years and two months. There were numerous pauses and cor-

rections along the way, all of which were preceded by bearish divergence.

However, a top of significant proportion was not reached until December

2004. This is a perfect example of how divergence is present at every turn,

but divergence does not always lead to a turn.

Divergence warns of trend reversal but does not always result in trend

reversal. Understanding why divergence occurs is key to understanding

market behavior in general. The strongest momentum reading usually oc-

curs either at the beginning or the middle of the trend, not the end. The

DJIA monthly chart with 12-month rate of change in Figure 6.15 best ex-

emplifies this dynamic. The greatest rate of change (12 months) occurred

during the 12 months that followed the July 1932 bottom. From July 1932 to

June 1933, the Dow gained 129 percent. No 12-month period since has seen

a gain of that magnitude (in percentage terms). Selling at the momentum

extreme in June 1933 would not have been a very good idea. The next de-

cent selling opportunity for the Dow would have been March 1937. Bearish

divergence warned of this turn (see Figure 6.15).

FIGURE 6.15 The momentum extreme in the Dow that was registered in the mid-

1930s gave way to the biggest equity ...