Price divergence is considered one of the powerful tools in technical analysis, as it helps traders discover trend reversals or momentum weakness in financial markets. Divergence relies on comparing price movement with technical indicators, such as the Relative Strength Index (RSI) or the Moving Average Convergence Divergence (MACD), to reveal discrepancies between actual trends and momentum.
What is Divergence?
Divergence is a condition where there is a discrepancy between price movement and technical indicators, indicating the potential for trend reversal or weakness in momentum. Divergence appears when the price is in a certain direction while the indicator moves in a different direction.
Types of Divergence
1️⃣ Positive Divergence
Occurs when the price is in a downward trend and forms lower lows, while the technical indicator forms higher lows. This type of divergence indicates weakness in the downward trend and the potential for a reversal to the upside.
🔹 Buy Signal:
If positive divergence appears at a strong support level, it may indicate buyers entering the market and the potential for a bullish wave to start.
📌 Practical Example:
If the price of the asset forms a lower low than the previous low, while the RSI indicator forms a higher low than the previous low, this indicates weakness among sellers and the potential for a price increase.
2️⃣ Negative Divergence
Occurs when the price is in an upward trend and forms higher highs, while the technical indicator forms lower highs. This type of divergence indicates weakness in the upward trend and the potential for a reversal to the downside.
🔹 Sell Signal:
If negative divergence appears at a strong resistance level, it may indicate weakness among buyers and the potential for a bearish wave to start.
📌 Practical Example:
If the price of the asset forms a higher high than the previous high, while the MACD indicator forms a lower high than the previous high, this indicates weakness in buying momentum and the potential for a price decrease.
Types of Divergence by Strength
🔸 Regular Divergence:
This is the most common type and is used to detect potential reversals of current trends.
🔸 Hidden Divergence:
It appears within ongoing trends and indicates the potential for the current trend to continue rather than reverse.
✳ Hidden Positive Divergence:
Occurs when the price forms a higher low than the previous low, while the indicator forms a lower low than the previous low, indicating a continuation of the upward trend.
✳ Hidden Negative Divergence:
Occurs when the price forms a lower high than the previous high, while the indicator forms a higher high than the previous high, indicating a continuation of the downward trend.
How to use divergence in trading?
✅ Step 1: Use indicators like RSI, MACD, or Stochastic to monitor divergences between price and momentum.
✅ Step 2: Ensure that the divergence occurs at strong support or resistance levels for further confirmation.
✅ Step 3: Wait for additional confirmation signals, such as reversal candlestick patterns or breakouts of trend lines.
✅ Step 4: Place the stop-loss below/above the confirmation level of the signal to reduce risks.
Conclusion
Divergence is a powerful tool that can enhance trading decisions, but it should not be used alone. It is best combined with other strategies such as support and resistance analysis or using other technical indicators to ensure the accuracy of signals. When used correctly, divergence can help you effectively identify entry and exit points and achieve better results in financial markets.
