Divergence and basing:
From an oversold state, if the stock is ready to rally, what I look for is an overbought reading on the 15m. From there, the stock should pull back a little as buyers are still skittish and sellers are still eager to get out.
For example, TSLA entered Oversold territory on the daily (the mother timeframe) on January 18th, before ER.
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Then on Monday the 22nd, the stock got to overbought on the 15m.
View attachment 1019276However, it was still far below the 10 SMA (green moving average) on the
daily (the only one that matters for MA tracking purpose) and it would take a good ER to spike up and reclaim it. We already know what happened. That was not the bottom.
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Once the SP touched 180 after ER, it bounced back up and reach overbought on the 15m for the 2nd time on January 29th.
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After running up a bit more, it dropped again and carved out a lower low at 175 on Feb 5th. However, at the close on that day, we had what we didn't have before, a bullish divergence on the daily RSI. What it means is the stock made a lower low on the daily, but its RSI is less negative than it was on the 25th @ 180. There were big sellers who relentlessly sold the stock without giving it any breather since 265 to 180, which is visualized on both the price chart and the RSI chart. The slope of the decline was steep. However, when we go from Jan 25th to Feb 5th, those sellers seem to have disappeared and the sellers present on that day failed to bring the stock back to its old steep decline trajectory. That's what a bullish divergence means. We need a lower low on the SP after a few days of consolidation which represents the disappointment and panic stemmed from what seemed like a failed attempt at rallying; these late sellers would soon be proven wrong.
Within 2 days, the stock popped back up and took out the declining 10 SMA at 186.5, a show of strength.
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From here, we were looking for more show of strength to be registered on the 1h, 2h, 4h and daily timeframe. What is this show of strength? It's when the stock reaches Overbought on each of these timeframes. It takes progressively more buying to reach it on the daily than it does on the 4h than it does on the 2h than it does on the 1h.
The implication of reaching overbought on each of these timeframes is the stock will have a very high chance of breaking that high after some consolidation. The consolidation that comes after reaching Overbought is the result of buyers still being skittish in this area. They want to take their profit fast and safely here so the early peaks get sold into more quickly than the ones that form later.
On 2/9, the stock almost reached Overbought on the hourly at 194 very early in the morning, pulled back and then made another attempt at cracking 194 in the afternoon, resulting a double top pattern with lower RSI reading. This is a bearish divergence that shows buying has dried up and it's time for a pullback for the skittishly bullish buyers to digest their gain.
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And indeed it sold all the way down to 182 on Tuesday. This was when a lot of people started panicking and began preparing for a lower low. However, the stock had shown us strength in 3 ways:
1. Bullish divergence on the daily, which should trump bearish divergence on the hourly
2. A reclaim, although briefly, of the 10 daily SMA
3. Overbought reading on the hourly
Once we're done with the hourly, it was the 2h turn. The stock reached it late Thursday 2/15 and then reached a peak of 201.3 early Friday 2/16. So it's shown strength on the 2h. Just like what happened on the hourly, what we can expect from here is:
1. Some consolidation that should last a bit longer than 2 days, which was the length of the last consolidation.
2. As the stock has reached overbought on the 2h, it should rally at the end of this consolidation and take out the peak on Friday
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However, as we're approaching the strong 209.3 resistance. Keep an eye out for a few things:
1. Yes, the stock has shown strength on the 2h, but will it show it on the 4h and take us up further? Meaning, once it has taken out 201.30 (closing over 201.3 on any 2h candle, not just breaking it intra-candle), will the next candles be green until it's reached overbought on the 4h?
2. On the day when it takes out 201.3, will the highest closing price far exceed 201.3, resulting in an even higher RSI reading on the 2h compared to the peak of 72.43 on Friday? If not, we're just going to have a bigger bearish divergence, now on the 2h, leading to another pullback which can morph into a full blown correction, possibly marking the end of this recovery.
1 and 2 are very closely related. If either one happens, the other often follows. However, we will be happy with just one. If none happens, then be very careful on that day and prepare for a steep correction. I sure hope the stock can go further than just the 2h timeframe but we trade the chart, not what we wish to happen.
For the record, the 4h RSI is right now sitting at 60.8. To reach 70, I estimate it needs to reach 215 minimum. The good news is it had reached it in both of the big DCBs we had in 2023.
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