Example 2 - Comprehensive 4H Look at Short Term Divergences:
Now, we will take a look at a comprehensive example of A/D divergence using 4 hour charts, which create signals that are actually timely and can provide insight for making correct trades. The period covered here will focus on August and September of 2005.
Figure 6 – A four hour chart of the EUR/USD pair from August 16th to September 3rd 2005.
The divergence occurs between price action and the indicator from the 25th to the 28th.
- Price sets new highs on the 25th for both the price and the A/D line.
- After several successive highs, the price sets a final new high on the 28th.
- The A/D indicator does not set a new high on the 28th.
- This combination is a bearish divergence signal. When the next week
starts, perhaps there is a run of pro-Dollar fundamental news or maybe
many investors are acting on the divergence signal at once; the end
result is that the price drops 160 pips.
- Price acquiesces to the selling pressure (distribution). After the drop, AD turns back up as investors start accumulating Euros.
A trader that studied the price action of the pair and saw this divergence over the weekend could have placed a short position since the rise in price at the end of the last week did not seem to be confirmed with volume.
The interesting thing is that this example is only the smallest divergence out of three during this period. Let’s explore the other two.
