Hello, dear readers of the techyadjectives.com! The article considers one of the most popular signals in trading — divergence. In the article, you will learn what divergence is in trading and technical analysis , what divergence speaks and signals about. You will also learn the difference between divergence and confirmation, as well as the main limitations of using divergence as a trading signal.
What is divergence?
Divergence is when the price of an asset moves in the opposite direction of a technical indicator, such as an oscillator, or moves contrary to other data. Divergence warns that the current price trend may be weakening, and in some cases may lead to a change in price direction.
There is positive and negative divergence (divergence). A positive divergence indicates a possible increase in the price of an asset. Negative divergence signals a possible decline in the value of an asset .
What does divergence say and signal?
Divergence in technical analysis can signal a significant positive or negative price movement. A positive divergence (also called a bullish divergence ) occurs when the price of an asset hits a new low while an indicator, such as money flow, begins to rise. Conversely, a negative divergence ( bearish divergence ) is when the price makes a new high while the indicator being analyzed makes a lower high.
Traders use divergence to gauge the underlying momentum of an asset ‘s price and to assess the likelihood of a price reversal. For example, investors can plot oscillators such as the Relative Strength Index (RSI) on a price chart. If a stock rises and makes new highs, ideally the RSI also makes new highs. If a stock , or any other asset and its price, is making new highs but the RSI is starting to make lower highs, this is a warning that the price’s uptrend may be weakening. This is a negative divergence (or bearish divergence) . The trader can then determine if he wants to exit the position or set a stop loss in case the price starts to decline.
A positive ( bullish ) divergence is the opposite. Imagine the stock price making new lows while the RSI makes higher lows with each stock price swing . Investors may conclude that lower lows in the stock price are losing their downward momentum and a trend reversal may soon follow.
Divergence is one of the common applications of many technical indicators, primarily oscillators.
The difference between divergence and confirmation
Divergence is when the price and the indicator tell the trader different things. Confirmation is when an indicator and price or several indicators tell the trader the same thing. Ideally , traders want confirmation to enter trades and during trades. If the price moves up, they want their indicators to signal that the price movement is likely to continue.
Limitations of using divergence in technical analysis
As with all forms of technical analysis , investors must use a combination of indicators and analysis techniques to confirm a trend reversal before acting on divergence alone. Divergence will not be present on all price reversals, so some other form of risk control or analysis must be used in conjunction with divergence.
Also, when a divergence occurs, it does not mean that the price will reverse or that a reversal will occur soon. Divergence can last for a long time, so trading solely on it can lead to significant losses if the price does not react properly.
- Divergence can occur between the price of an asset and almost any technical or fundamental indicator or data. However, divergence is commonly used by traders when the price moves in the opposite direction of the technical indicator.
- A positive divergence signals that the price may start moving up soon. This happens when the price is moving down but the technical indicator is moving up or showing bullish signals.
- Negative divergence indicates lower prices in the future. This happens when the price is moving up but the technical indicator is moving down or showing bearish signals.
- Divergence cannot be solely relied upon as it does not provide specific time trading signals. A divergence can last for a long time without a price reversal.
- Divergence is not present for all major price reversals, it is present only for some.
And that’s all about divergence . I hope the article was useful to you. Share the article on social networks and instant messengers and bookmark the site. Good luck and see you on the pages of the techyadjectives.com !