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What In The Order Flow Causes Divergence?
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What In The Order Flow Causes Divergence?

  #11 (permalink)
Market Wizard
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matthew28 View Post
Just in the spirit of carrying on the conversation I am not sure I would completely agree that you can't read divergence on the tape or DOM. But maybe this just becomes a question of semantics. For me divergence is simply when something should happen but doesn't, and doesn't have to relate to an indicator. Such as in my earlier point when you see a lot of volume selling aggressively on the tape but price doesn't go down.

Yeah, I would agree with that.

Divergence, in a large sense, just means something like, "Huh? What's that?" -- that is, some relation should have existed, or something should have agreed, but didn't.

For example, if the ES (S&P futures) is moving up but NQ (Nasdaq futures) is moving down, you have two things that are somewhat similar (both stock index futures) that are out of step. This kind of divergence can be very informative. It means, "Be alert, something unusual is happening." In this case, two groups of stocks that have different characteristics are not acting the same. Maybe the market is looking to avoid risk, or maybe something else.... The divergence doesn't tell you what will happen, just that something is out of whack now. You have to see if you can figure it out.

As to the DOM, well, if selling pressure can't move the tape, that means something, no matter what it is called.

So no disagreement here; I was just addressing the MACD/RSI question, sort of in a more narrow way.

Bob.

Edit: I just noticed that right now, the NQ is moving up and the ES has gone sideways into a range (well, I knew the ES was ranging, but hadn't looked at NQ.) That may mean something now: higher cap stocks underperforming the tech-heavy, usually riskier index. So there's a real-time example unfolding. But what it means is always the question. Just that something is out of whack, and there's a heads up....


Last edited by bobwest; August 9th, 2015 at 04:05 PM.
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  #12 (permalink)
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matthew28 View Post
Just in the spirit of carrying on the conversation I am not sure I would completely agree that you can't read divergence on the tape or DOM. But maybe this just becomes a question of semantics. For me divergence is simply when something should happen but doesn't, and doesn't have to relate to an indicator.

Without getting into discussions about semantics or about redefining terms, you are more likely referring to The Dog That Didn't Bark:

A Sherlock Holmes short story, "Silver Blaze", has to do with the disappearance of a race horse and the murder of its trainer. Holmes suspects that Scotland Yard Inspector Gregory has the wrong man because of what he terms a "curious incident":

Gregory: "Is there any other point to which you would wish to draw my attention?"

Holmes: "To the curious incident of the dog in the night-time."

Gregory: "The dog did nothing in the night-time."

Holmes: "That was the curious incident."

The fact that the dog did nothing, didn't bark, suggests to Holmes that the dog knew the perpetrator, that he was not a stranger but rather a friend of the family or even a member of the family itself.

The dog did not do what one would expect it to do under normal circumstances. When price doesn't do what one expects it to do under normal circumstances, one should at least begin to suspect that "something is afoot". Yes, it's silly. But it provides the trader with a mental hook on which to hang his thoughts and examine them.


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When price first drops out of that narrow range (1), one expects it to continue its move downward. But it doesn't. When it drops out of the range a second time (2), it still doesn't, even though it makes a lower low. If price does not do what's expected, it will more likely do the opposite. If price won't fall, either buyers are supporting it or sellers aren't very motivated to sell. Either way, pressing for a short entry will not likely be productive. Price isn't doing what's expected. The dog isn't barking.

All goes well until price tries to make a higher high at (3). The trend is up, there is a series of higher highs and higher lows, but then price doesn't do what it's expected to do, i.e., make a higher high. The dog doesn't bark. So price reverses and begins a downtrend, lower highs, lower lows until price reaches (4). Price doesn't do the expected thing. It doesn't make a lower low. The dog doesn't bark. Price reverses and begins a new uptrend.

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The clearest way to see divergence in order flow is using the Cumulative Delta indicator.

If the market is moving down/flat but order flow (market orders) are predominantly buy-side then the cumulative delta will rise.

That could mean buyers are getting trapped or it could just mean it's a volatile market where sellers are taking advantage of the volatility by taking the offer side.

So it's market specific. If your market generally has the delta following price and then it doesn't - it's meaningful.

Some markets through - it'd the norm.

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DionysusToast View Post
The clearest way to see divergence in order flow is using the Cumulative Delta indicator.

If the market is moving down/flat but order flow (market orders) are predominantly buy-side then the cumulative delta will rise.

That could mean buyers are getting trapped or it could just mean it's a volatile market where sellers are taking advantage of the volatility by taking the offer side.

So it's market specific. If your market generally has the delta following price and then it doesn't - it's meaningful.

Some markets through - it'd the norm.

Good to see an order-flow specific response to the question.

Thanks for clarifying.

Bob.

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