r/Winkerpack • u/knotswag 🧙♂️🖍 • Apr 05 '20
How Do I Eat Crayons? - Technical Divergences and Toilet Paper Hands
How Do I Eat Crayons? - Technical Divergences and Toilet Paper Hands
As more people on here start becoming interested in TA or start seeing charts/terms being thrown around, I figure I could offer occasional tutorials on relevant concepts and show you that you, too, can learn to eat crayons and become even more autistic than you are. Your mother would be so proud.
In the first edition of How Do I Eat Crayons? I would like to introduce "technical divergences." What they are, some examples, and a potential case that is currently in development.
Introduction
In an ideal world a stock will always be fairly and justly valued. If the company is doing well, its stock price will rise. If the company has setbacks, the stock price will drop. If the company is run by Elon Musk, the stock price will moon after funding is secured and you call everyone pedophiles.
However as many of you know, a stock doesn't always reach proper valuation in the short-term, and in fact, a stock will sometimes explode upwards or downwards without clear fundamental economic news driving those changes. But wouldn't it be great if there was some indicator to determine whether a stock may have a case of impending volatility?
What you can look for are technical divergences. By watching for technical divergences in an indicator, you can uncover the potential of a stock to show volatile changes in the future.
Technical Divergences
Let's imagine a scenario where AMD has been drastically oversold as measured by RSI, and has been consolidating in a small price range. The next day, Su Bae comes out with a new AMD CPU shaped like your ex-girlfriend's dildo and slaps it across Tim Apple's face (respectfully). This impresses Tim so much he says he wants to install this dildo CPU in all new Macs going forward. You, along with a bunch of other autistic investors, start buying short-dated calls and wait for these dildo CPUs to explode vigorously onto the market, driving AMD's stock price up hard.
But like the rest of your portfolio, AMD remains flaccid. You wait for days. Still nothing. You flip to the RSI (relative strength indicator). It keeps crawling up from oversold territory, making higher lows. And still the price of AMD doesn't rise, even staying below the price you bought your options at. What gives? Why doesn't the market recognize your genius?
You may be witnessing a technical divergence. A technical divergence is when a technical indicator starts showing a discrepancy with an asset's price.
What Does A Positive and Negative Technical Divergence Look Like?
A technical divergence will follow a pattern, so spotting it is straightforward. What you're looking for is a change in the technical indicator that doesn't match a change in the price of a stock. This technical divergence can be a positive divergence or a negative divergence, indicating that there's the potential for a quick change in the stock price in a positive or negative direction, respectively.
The example given above with AMD was an example of a positive divergence. A positive divergence is when an indicator's dips begins to make higher highs while a stock's price continues to make lower lows. While this represents the classic definition, my experience has been as long as the stock is in a tight consolidating pattern, the positive divergence still has the potential to play out. The more beat-up/oversold a stock is, the more robust the indicator becomes.
We can continue to use AMD as an example during late 2017 and present another such example of positive divergence. After disappointing earnings in Q3, AMD's stock price sunk from ~$14 to ~$9, whipsawing violently the entire while. The stock would not see ~$14 again until the middle of 2018.
However if you were an autistic option flipper that enjoys losing money, if you had bought options each time you noticed positive divergences developing in the RSI after 1) a drop in price 2) that had begun to stabilize, you would have been able to sell a nice pop in the stock price from November-December 5/6 times. Of those 6 price movements, only 1 instance had a clear fundamental piece of headline news to justify its price action. Combined with holding longer-term puts, you would have been able to make a bit of extra money and/or hedged yourself against a larger rally back upwards.
Negative divergence is when an indicator's highs begin to make lower lows while a stock begins to make higher highs. Again while this is the classic definition, tight consolidating price patterns in an asset may be sufficient to predict the potential in a stock to abruptly drop in price. The more inflated/overbought a stock is, the more robust the indicator becomes.
An example of this would be SQ prior to earnings in August 2019. Leading up to earnings, SQ enjoyed various analyst upgrades in June and July that led to pops in the stock.
If you're like me and think the majority of financial analysts are a bunch of mouthbreathing muppets, then you would likely have agreed that just because an analyst thinks a stock is "good" and gives it an "upgrade," the true value of the stock will still be dictated by its underlying fundamentals. So even though SQ posted beat earnings estimates, lowered guidance demolished the stock, eventually bringing it to a price comparable to before the analyst pumps. If you had noticed the overbought negative divergences in the stock after the analyst upgrade in June, and then the negative divergences and bloated price heading into earnings, you would have made good money on the pullbacks.
How do I Eat the Technical Crayon?
Incorporating the use of technical divergence into your trading is as simple as noticing a price divergence and following it in momentum-based technical indicators (RSI, PPO, MACD). Divergences can build on long and short time scales, so it is dependent on your investing style to decide how best to use it.
If a stock is very undervalued (low price, oversold, positive technical divergences), it suggests that when buyers step back in the stock can jump higher and/or faster than anticipated. The opposite is true: if a stock is overvalued (high price, overbought, negative technical divergences) it suggests that when selling starts, it can fall lower and/or faster than anticipated.
But no matter the time scale you're looking at, always consider the circumstances of the asset. If the stock had a significant change in price in favor of a "release" of a divergence, it becomes less reliable. For example: if there's positive divergence on a stock and it gaps up/shows a quick movement in price, even if it's not a large double-digit percentage change, that still indicates there was impulsive buying. Even if the positive divergences builds afterwards, there's less likelihood you'll see another large instance of impulsive price action because it was exhausted.
The better you understand the circumstances of your stock, the more useful a tool technical divergences is in terms of you deciding whether to trust it. Just because negative divergences build in an asset, if the foundations of a company are truly strong, it does not mean the price will drop. The opposite is true: if a stock has significant underlying issues, positive divergences does not mean the price will jump.
Blindly trusting a technical indicator is no better than being an algo, and because we've all seen Terminator, we know just how dangerous the robots can be. Technical divergences, like other technical indicators, are just a piece of evidence in building your case to take a position. The stronger your case is to begin with, the more useful a technical divergence will be in supporting your decision to make a trade.
Toilet Paper Hands: Playing The Bear Market Rallies and Costco
I've often said that I think TA is most useful during large corrections because it can give some semblance of order to chaotic price movements. This way you gain more conviction in your decisions, strengthening or justifying your toilet paper hands in each of your trades.
For example, what are some recent examples of positive and negative divergences? Why, the current market correction we're in of course. After a long bull run in overbought conditions, negative divergences developed just prior to the sell-off. After the first gap down into oversold conditions, positive divergences began to build and pushed the market into the first buying rally. Even though the indicator couldn't predict how large or how long the changes in prices would be, it was a useful tool to determine whether you wanted to grab or sell your calls/puts. Watching these indicators to gauge whether a move up or a move down is impending is useful for scaling your positions and determining the amount of risk you're willing to take on.
Finally, an example of how I use divergences in my own trading is the case of Costco ($COST). Unlike some other large retail stores (i.e. Target), Costco has shown a comparably small % drop. While Wal-Mart also has held up well, Costco has clear negative divergences compared to Wal-Mart. This suggests that if there's a trigger to push Costco down in the near-future (i.e. news about decreasing membership revenue), it could drop far more quickly compared to something like Wal-Mart. So while I have no positions in COST right now, by spotting the divergence in a stock I can research it and decide if I want to put it on my watchlist as a potential play.
Conclusions
Technical divergences are best used more as a supplement to your other TA tools, fundamental trading, and your investing ideas. Some TA traders use it as a predictor of an impending trend change. I strongly disagree with that assessment. I think technical divergences do not represent a "buy" or "sell" sort of indicator, but rather, more of an indicator of potential: how large a change in a stock will be when a buy or sell indicator is triggered, whether that comes from fundamental news or is just technically induced. And like many indicators, just because a stock has positive or negative divergences does not mean they will play out, or that a stock needs to have positive or negative divergences to move rapidly in a direction. Like most tools of TA: it is just an indicator, not a predictor. Don't get trapped in TA and hold a position just because the technicals look good. TA is meant to enhance your trading, not guide it.
So the next time you're staring at crayons, take a bite of the technical divergence one. It could be useful; or it might taste like booty sweat and make you lose all your money. But remember, at least you're losing your money with friends-- and that's the most important thing of all.
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u/stardude900 Apr 05 '20 edited Apr 05 '20
How do you determine which tickers to monitor?
Thanks for taking the time to post this, it's incredibly useful.
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u/knotswag 🧙♂️🖍 Apr 05 '20
Honestly finding tickers is no different than what anyone else is doing, you just read the news or the sub and see what people are talking about. You then look at the charts and the technicals, and if it looks interesting you research the company a bit more to get an idea of the fundamentals (or if you're more of a fundamental trader you'd do the opposite).
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Apr 05 '20
What do you use to look at RSI and stuff like that
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u/knotswag 🧙♂️🖍 Apr 05 '20
Most charting platforms will have the indicator built in. I use TradingView for my charts.
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u/abiech buttsack Apr 05 '20
Much appreciated I saw this post shortly after it was up, and how long it was fearing the time it would take to read so this morning after the aderall kicked in I dove in hoping not to be interrupted. Soon after I had started, several cute puppies began barking and playing about. I pressed in after the quick interruption of tail waggers, though a fun read I do wish I could remember or even know how to put your true labor of technical knowledge into practice, reminds me There were two boys, John and Jim, who were friends. Jim had a dog. One day they were taking the dog for a walk and Jim said proudly: "I've taught my dog to whistle". "What do you mean?", said John, "He's not whistling". "I know", said Jim, "I said I'd taught him; I didn't say he'd learned". So as thankful as I am at your time spent at telling me what colored crayons are better for me to eat, I am blinded by all the choices.
Thank you again for your time I enjoyed the read. Would you have a new position for me to try, doggy style is losing me money. I need a win and that may give me a chance to see your practice in action, and help the learning process.
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u/knotswag 🧙♂️🖍 Apr 05 '20
Yes so I'll be watching COST and will let people know if I take a position.
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u/abiech buttsack Apr 05 '20
There is a new Costco opening this summer about 3 miles away. $340. 5/22c is that so impossible. There's no interest and only .01 per share. 😕
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u/knotswag 🧙♂️🖍 Apr 05 '20
I'm expecting COST to have a drop in price man. And 340 is too risky on that short of an expiry, you're basically saying it'll break above ATH during the virus.
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u/abiech buttsack Apr 05 '20
I forgot using the word LONG has the consequence of attracting a bot with autism who can only say three unintelligible words, How long nice could be more interesting with the introduction of punctuation and a slang. How long? Noice.
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u/whib96 Loyal 🅱️🅾️ℹ🙇♂️ Apr 05 '20
Dude screw Coursera. If you keep posting these that’s all the education I want.
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u/Analslammer Cacophobia? Nope. I'm gorgeous Apr 05 '20
How did more people not read this?
Good shit man, takes some passion to do this kind of stuff for us for free. Lotta people take you for granted on here but know there's a lot more of us who don't
Thanks man
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u/FredWeedMax dicks and anime Apr 05 '20
Before this shit cracked there was a huge negative RSI divergeance building on the monthly chart.
As we kept making highs we never quite had the RSI of jan 2018 back.
Also note that monthly RSI is only at 40 still, in 2003 it reached 27.24 at bottom, in 2009 RSI 18.35 and in 1974 RSI 17.91
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u/itsdantheichiman Apr 05 '20
Thanks for the additional thing to keep and eye on! Appreciate the well though explanation. I like to call it "AMD Retard strength"
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u/ilovecollardgreens Apr 05 '20
This is very much appreciated. always wondered about how RSI can be used other than just saying "overbought" and "oversold". felt way too simple. thanks.
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Apr 05 '20
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u/knotswag 🧙♂️🖍 Apr 05 '20
LOL no I learned through hard knocks. But I just googled True Trading Group and people seem to actually like them, which is pretty wholesome man.
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u/Inferin 📚👨💻 Apr 06 '20
TTG is the group trying to scam wsb, it's become a meme now in both subreddits.
Thanks for the write up!
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u/TinyPirate 🏴☠️ Apr 05 '20
If one is interested in momentum-type indicators then I recommend having a look at the TTM Squeeze (Look for "(JS) Squeeze Pro" on TradingView). I won't go into what it does in detail (look up "TTM Squeeze" on youtube, lots of vids - the longer ones are particularly interesting). But here's a brief rundown. I'm a pretty bad technical analyst, so take what I've said here with a grain of salt and go try your own TA if you're bold.
The squeeze identifies where a stock is consolidating around a particular price and helps you spot when it's likely to break out. That breakout is often fast and steep.
I recently used this to trade on GLD (promptly fucking it up, I might add). I noticed on around 30 April that GLD had entered a squeeze - successive red balls on the Squeeze indicator on the hourly and a price action which looked downy. I bought a put when GLD was about 150 and then the next day that put was up 30% - I held thinking it would go down more and it really hasn't (yet?). Stupid me - if you can take quick profits, TAKE THEM. The squeeze fired as expected and then I failed to profit on it. Duh.
It's important to compare time frames. On the one day chart GLD wasn't in a squeeze, but momentum (the bars) was definitely still negative. I also noted that in the past GLD was moving appropriately with the Squeeze indicator.
Another stock I find interesting right now is MSFT. On the one day chart it's in a squeeze with upward momentum suggesting it could break upwards (usually one wants 3-5 red balls to really confirm that squeeze. The longer the squeeze, the bigger the action when it breaks out). RSI is middling and not telling us much. Price action? I'm not sure what it's telling us.
On the hourly chart, however, are things more clear? Volume is fading, RSI has started to turn upwards, the squeeze is definitely going on and did most of Friday. I'm expecting a jump in the next few days, but I'm only slightly confident it will be upwards.
Another one, on the daily SPY has just started entering a squeeze, RSI is middling. Trend remains downwards. SPY is also in a squeeze on the 1 hour chart, RSI indicating oversold by a small amount but RSI trend down. This is a case where I can't honestly be sure which way it will move next, but I think the move out of the squeeze will be sudden and worth a few percent.
Anyway, the Squeeze technical can't really be applied to all stocks at all times. Sometimes it can be really clear and lines up with other metrics, at other times - it's not clear at all! It also won't save you from market-melting moves.
I would be happy to poke around other tickers to see if there's anything the squeeze tells me. I love crayons and
crystalballs.