Most financial analysts, wealth managers and media do not understand the importance of tracking negative or positive divergences in the leading indicators of the market which includes insider’s buy and sell, the VIX (the volatility index) and the leading commodity ETFs. Since it is impossible to know when a market downtrend or a rally is going to happen, identifying these divergences ahead of a trend change is vital to profitable asset allocation and preservation of capital. The discipline of investing with an eye on the divergence factor is mentally and emotionally challenging even for the best of us.

For example, consider the recent risk asset rally that was preceded by a 20% plunge. Prior to the August 2011 plunge, we observed the negative divergence from April through July which prompted us to buy into TLT and TIP, which are safe-haven assets. When the plunge happened, from August to December 2011, we positioned ourselves in risk assets because we noted a mounting pattern of positive divergence. These subtle developments cannot give you an idea as to the exact date of a bear market or a bull market. Frankly, it doesn’t matter because eventually it just happens. And when it does, most of the market participants will lose money. The market just has a way of punishing short term traders who do not exercise patience to monitor and adjust for these factors.

What does matter is to adjust your asset allocation ahead of the trend change in order to benefit from the rally in that asset class before the good news is confirmed by the media and the charts. Keep in mind that all the chart slaves, momentum players, and hedge fund managers as well average investors tend to wait for confirmation of a trend change. Only savvy, experienced, and not so greedy investors are usually rewarded by positioning themselves in advance of a trend change.

Here at ETF Trade Advisor we constantly look for these patterns of divergence in order to issue the most profitable buy and sell signals for our subscribers and our own portfolios.