Technical Analysis - DivergenceReading Time: 8 Min Experience Level:Expert
Divergence
in technical analysis is when we observe the movement of the price in a
direction other than a technical indicator, or is moving against what other
data is saying.
This
gives a warning that the current price direction may be weakening, and might
lead to a change in the current trend.
Divergence
has two scenarios.
Bearish divergence: A signal of
weakening upwards momentum, or a downward correction. This might occur when the
price creates a higher high, and at the same time, the indicator would be
making a lower high.
Bullish
divergence: A signal of exhausted downward momentum, or an upward
correction. This might occur when the price creates a lower low, and at the
same time, the indicator would be making a higher low.
What is
it?
Oscillators
are a trading tool that can be misunderstood. The oscillators that we will
concentrate are momentum indicators. Markets move because of supply
and demand and fear and greed. Momentum oscillators are a measure of these
movement
When
bearish or bullish price moves start to lose their momentum, divergence occurs.
The
easiest way to explain this is to look at a Wedge formation:
Ascending Wedge with Bearish Divergence:
Source: TradingView
The
chart above highlights an Ascending Wedge formation. We have a
trend of higher lows and a trend of higher highs. What makes the wedge is
the lower trend support is at an angle of 20 degrees. The upper
trend line resistance is at an angle of just 5 degrees. These angles will vary.
What is important in an Ascending Bearish Wedge is that the upper trend line
resistance is a lower angle than the lower trend line support.
What
else can we note? The distance of the first impulse rally is 8.71% or 876 pips. The second impulse
rally is 5.68% or 574 pips. This highlights that bulls are starting to loss
strong upside momentum with shorter rallies. The wedge is like a coiled spring,
with rallies getting smaller and smaller, and the wedge getting tighter a
tighter, ready for an impulse breakout to the downside.
As we
can see, the chart is making a higher high, while the oscillator is making a
lower high, indicating a bearish divergence.
Bearish Divergence can
be seen. The chart makes a higher high, while the oscillator makes a lower
high.
What
indicators should I use?
This
can be your own preference. We would suggest any of the following:
- RSI
(Relative Strength Index)
- Momentum
- RoC –
Rate of Change
- Stochastics
Where
am I likely to see Divergence
Chart
formations that are likely to highlight divergence are:
Double
or Treble Bottom or Top.
Wedges
The 5th wave in Elliott Wave.
