Ask Colin

Do you have a view on the large negative divergence on the Dow Jones Industrial Average Coppock indicator in the run up to the 1999/2000 top?

The Coppock indicator is a long-term momentum oscillator. In a sustained trend, all momentum oscillators will form divergences unless an uptrend accelerates quite dramatically. The same will occur with a downtrend, for the same reason.

It is a basic rule in using a momentum oscillator in an uptrend that we only sell on divergences to take profits on swings in the trend. If we are trying to trade the entire trend, then divergences will tend to throw us out too soon.

My view of divergences is that they are of little practical use for trend trading. This is because there will tend to be a divergence at most trend endings, but there will also be many divergences that do not signal a trend ending.

The way this feature of momentum oscillators is usually handled is that a trend trader only acts on a divergence if there is a signal to sell from the price chart or a trend-following indicator that confirms it.

The Coppock generally works reasonably well, because it only gives one signal - to start buying when it turns up below zero. Everything else tends to be unreliable and was never a part of Ed Coppock's design of the indicator. The time it does not work so well is when there is a long, slow bear market. So, after the 2000 top, we got some very premature signals on the US Coppock indicators. Usually, it works better than this, because bear markets are short and sharp. The Australian Coppock was a good example of the ideal signal.