Bearish Divergences: A Cautionary Tale in Two Growth Stocks
To start, it is essential to understand the terminologies before delving into the specifics. A bearish divergence, commonly known as a negative divergence, occurs when an asset’s price reaches new highs, but key indicators used to gauge its performance (like the Relative Strength Index or Moving Average Convergence Divergence) fail to confirm these peaks, showing lower highs instead. Therefore, it provides a hint that the observed bullish run may be exhausting itself, signifying the possibility of a trend reversal looming.
Now, let’s examine the emergence of bearish divergences in two specific growth stocks: Stock A and Stock B, which we will denote for the sake of confidentiality.
Studying Trends in Stock A
Stock A, a household name in the technology-driven NASDAQ market, exhibited an exceptional bull run, representing a five-year growth rate of close to 300%. Expert analysts, employing the use of the Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD), recently discovered a noticeable bearish divergence. The price action was still trending upwards, hitting fresh highs; however, both the RSI and MACD produced lower highs. The RSI portrayed signs of overbought zones without a corresponding surge in MACD.
This dual information suggests that, despite the persistent uptrend in price, the momentum was losing strength, and a reversal in trend was on the horizon. For prospective investors, this implies the need to exercise caution before making new long investments in stock A.
Observing Developments in Stock B
On the other hand, Stock B is a leader in the consumer discretionary sector that has been riding the bullish wave, with approximately 200% growth over the past three years. A closer inspection of the stock’s recent performance using the On-Balance Volume (OBV) and Money Flow Index (MFI) indicates a bearish divergence.
Even as Stock B made gains, the OBV began to trend downwards, suggesting that volume on down days was heavier than on up days. The MFI also demonstrated a similar pattern, recording lower peaks even as the price made higher highs. Subsequently, the share price started to decline, and a possible bearish reversal became increasingly likely.
These analysis disproves the adage that the trend is your friend holds true all the time. More than just price movements, volume, momentum, money flows and many other aspects should be considered when making investment decisions.
In conclusion, the bearish divergences in these growth stocks should sound the alarm bell for investors and traders alike. While they demonstrate exceptional performance over the past few years, they are also showing signs of slowing momentum – a strong indication of a potential reversal to a bearish trend. As an investor, one must always remain vigilant, factoring in both bearish and bullish signals, to make the best out of investing in growth stocks. Financial markets are dynamic, so it’s important to remain cognizant of these changes for maximum capital preservation and growth.
