DivergenceWhat Is A Divergence?
Divergence is a mismatch or imbalance between the price and its oscillator. In order to better understand a divergence, we need to understand what the oscillators are. Oscillators are basically time indicators which can be calculated by measuring a set of prices over the last period: thiscalculation provides a rate showing the potential strength or weakness of their trend.
If, when there’s a new maximum/minimum price, the oscillator shows a newincrease/decrease equal to the price change, then the technical condition of the market is consideredstrong. However, if a new maximum/minimum price doesn’t reflect a similar increase/decrease of the indicator, technically we call this a "divergence". This kind of discrepancy usually indicates that a price will likely go through a corrective process, which can lead to an inversion of the latest ongoing trend.
The occurrence ofa divergence between price and indicator during an uptrend stage means that buyers have exhausted their momentum and, as a result, have reached the peak price which is likely to fall soon, more or less quickly. The same process happens in the opposite situation.
Divergences are of two basic types, Classic/Regular divergence and Hidden divergence which can be bullish or bearish direction. For the rest of this explanation we shall stick to Classic divergence over Regular for simplicity sake.
This type of divergence basically indicates a change in a current trend direction e.g. from bullish to bearish or vise versa. However it could also indicate that a markets current trend on the time frame the divergence occurred is undergoing a correction/retracement. In other words, a Classic divergence could lead to a price going into a range/retracement on the current time frame, or a complete change in the particular trend.
Bullish classic divergence: when this occurs, you will observe price making a lower low in a down trend, while the oscillator makes a higher low.
Bearish classic divergence: Price making a higher high in an uptrend, while the oscillator makes lower high will be observed.
This type of divergence indicates continuation i.e. end of retracement of a particular trend. The trend in question here can easily be viewed on the immediate higher time frame. For example, a divergence on the 4hr [H4] chart signals a continuation of the daily [D1] chart.
For a bullish hidden divergence, price is making a higher low in an uptrend, while the oscillator makes lower low.
For a bearish hidden divergence, price is making a lower high in a downtrend, while the oscillator makes higher low.
CLASSIC & HIDDEN DIVERGENCE
A picture they say speaks louder than a thousand words. In order to better explain what a divergence is, it is good practice to take a look at a few real life examples of forex and crypto currency charts.
Examples of oscillators
MACD indicator, RSI, Average Directional Movement index, Accumulation/Distribution indicator, William’s Percent Range etc.
The Market Crash of 2008 was indicated by a Classic Bearish Divergence
CURRENT BULL RUN OF THE EURUSD IS ALSO SHOWN ON THE MONTHLY TIME FRAME VIA CLASSIC BULLISH DIVERGENCE
BITCOIN VS US DOLLAR MONTHLY CHARTS SHOWING CLASSIC DIVERGENCE AND HIDDEN DIVERGENCE SETUPS
the Analyst's answerJean Grossett - Financial analyst
These are my best tips:
– Choice of oscillator is very important when identifying divergence patterns.
– Never use repainting indicators (Oscillators) as these can give you false signals.
– Please note that for divergence to be confirmed, it is best to use an oscillator that shows crossover. This is to prevent jumping too early into a market (The fear of missing out), never forget that price is King.
– Always get out of the divergence setup at the signal of an opposite divergence setup, or an opposite crossover. Cut your losses quickly, and never fall in love with your trade/signal (The fear of being wrong).
– In order for divergence to be effective, an analyst must use it in combination with other tools. S/he should consider the major price trend at play and timeframe, how it relates to current economic fundamental trends of the currency pair or commodity.
the Manager's answerRobert Danvil - Investment Manager
Divergence and oscillator are considered the holy grail of technical analysis by some traders, while for others it is virtually useless. The truth is the use of divergence is dependent on the trader’s method of trading. It is important to understand that trading signals derived from divergence which is based on oscillator indicators can sometimes be misleading due to its delicate pattern. A trader is always told to ensure that the signals are interpreted correctly before some execution is done. Divergence shows a trader that the price is changing for a given asset and that a decision must be taken to ensure any SL (Stop Loss) or TP (Take Profit). Therefore it is necessary to understand the trade signals and executes it with the right strategy to make profits on your trades.
Divergence is important for trade management, and it indicates that something in the market is changing. However, it does the mean the trends will reverse. The signals are only a tool to enhance your understandability of the market, and a profit can be only achieved with the right set of strategic options. To be able to reach profitability, one should consider picking up the right strategy for what price is doing, not what we think the price will do, or the trends will act like.