Divergence
Tue, Apr 15Divergence is a concept in technical analysis that refers to a situation where the price of an asset moves in the opposite direction of another data point, typically a technical indicator. For instance, if the price starts to show a negative correlation with an indicator (e.g., "higher highs" in price but "lower highs" in the indicator), this may serve as a leading signal for a potential shift in price direction.
Traders utilize divergences to assess whether a market trend is weakening, which could indicate a period of consolidation or a reversal of the trend. Trading volume is a straightforward example of an indicator that can create divergences. In this scenario, a divergence occurs when the price moves contrary to the trading volume. For example, if the price rises while the volume decreases, a divergence is present.
While divergences can arise between an asset's price and any other data, they are most frequently analyzed in conjunction with technical indicators, particularly momentum oscillators like the Commodity Channel Index (CCI), Relative Strength Index (RSI), Stochastic, and Williams %R.
There are TWO types of divergence: Regular and Hidden. Each type can exhibit either a bullish or bearish bias.
Regular Divergence
If the price is forming lower lows (LL) while the oscillator is creating higher lows (HL), this is identified as regular BULLISH divergence. Conversely, if the price is making a higher high (HH) but the oscillator is producing a lower high (LH), this indicates regular BEARISH divergence.
Hidden Divergence
In an uptrend, if the price establishes a higher low (HL), check if the oscillator does the same. If it instead makes a lower low (LL), this represents hidden BULLISH divergence. In a downtrend, if the price forms a lower high (LH), verify if the oscillator follows suit. If it makes a higher high (HH) instead, this indicates hidden BEARISH divergence.
It is important to note that regular divergences may signal potential trend reversals, while hidden divergences suggest trend continuation.
Regular divergences = signal a possible trend reversal.
Hidden divergences = signal a possible trend continuation.
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