Divergences on Industry Groups

By David Vomund

AIQ's Price Volume Divergence report was introduced in our first version of TradingExpert for Windows. It immediately became a very popular report. We tested this report's effectiveness on stock selection in the December 1995 Opening Bell and found that there was a one percent difference per month between the stocks that appeared in the positive divergence section compared to the stocks that appeared in the negative divergence section. With these encouraging results, we decided the report should be available for groups and sectors as well as stocks. In this article, we'll apply the same test to industry groups.

Before we report results of our testing, let's review how the Price Volume Divergence report works. By default, this report looks for divergences between the price action of a security and the readings of the security's On Balance Volume and Money Flow indicators. A positive divergence occurs when the security falls in price over the last 15 days but a composite reading of the slopes of these two indicators increases in value. An example is found in Figure 1.

In this example, the Aerospace/Defense group made a new high in mid-October and then began to move lower. There is a pattern of lower lows (see trendline). Looking at the On Balance Volume and Money Flow indicators, we see both indicators have moved higher over the same 15 day time period. Both the time period used in the calculation along with the weighting of each indicator can be changed under the Daily Stock Criteria screen.

In our testing, we ran the Price Volume Divergence report on the Standard & Poor's industry group structure at the beginning of each month. We then calculated the average monthly return on the top three groups that appeared on the positive divergence section and the negative divergence section. A new report was run each month going back to January 1995. The results were found in Table 1. In Table 1, we see that the highest rated three groups that appear in the positive divergence section increase an average of 2.52% per month. The top three groups that appear in the negative divergence section increase 1.12% per month. The S&P 500 index increased an average of 2.22% per month. This is what we hoped would happen. The groups showing positive divergences on average outperformed the S&P 500 and the groups showing negative divergences underperformed the S&P 500. There is a 1.4% difference per month between the groups that have positive divergences compared to the groups that have negative divergences. There was no backfitting or optimizing involved in this study.

TradingExpert's strength has always been its industry group analysis. With the ability to screen for positive and negative divergences, our group analysis is even more powerful. The Price Volume Divergence report is effective in forecasting short term movement in industry groups. It is also an anticipatory report. That is, in order to appear on the positive divergence section, the groups must have decreased over the last 15 days. The opposite is true for the groups showing negative divergences.