If you have been in the market for some time, you may have heard of something called “divergence trading”. Today I am going to share an informative write-up along with a few exhibits that may help you solidify your understanding of this important trading concept. This post will also lay the groundwork for future posts about related topics.
Please remember this is an educational post to help all of our members better understand various concepts used in trading or investing. This in no way promotes a particular style of trading!
In this post, I am going to cover the following topics on divergence trading:
1. What is divergence?
2. What are the different types of divergence?
– Bullish divergence or Positive divergence
– Bearish divergence or Negative divergence
When the stock price moves in a specific direction, the momentum oscillator should also move in the same direction.
Example: When the Price makes a higher high, the momentum oscillator should also make a higher high. This is called convergence since both the price and the momentum are converging in the same direction. In a few circumstances, the momentum oscillator and the price do not move in tandem. This is called divergence and the system of trading is called divergence trading.
What is Divergence?
When the price of an asset is moving in the opposite direction of a technical indicator, such as an oscillator, it is called divergence. Divergence warns about potential underlying weakness in the current trend. The price may or may not reverse at the exact occurrence of the divergence.
Different types of Divergence
Broadly, divergence can be classified as positive or negative. Positive divergence is also known as “Bullish divergence”, while the negative divergence is typically called “Bearish divergence.”
1. Bullish divergence / Positive divergence
A bullish divergence occurs when prices fall to a new low while the oscillator fails to reach a new low (exception being hidden bullish divergence ). Positive divergence signals that the price could start moving higher soon. It has two sub-types:
i) Regular Bullish divergence
ii) Hidden Bullish divergence
Some exhibits of Bullish divergence:
Exhibit 1: Classic bullish divergence
Exhibit 2: Hidden bullish divergence
Exhibit 3: Bullish divergence followed by a subsequent reversal
2. Bearish divergence/Negative divergence
A bearish divergence occurs when the price rises to a new high while the oscillator fails to reach a new high (exception being hidden bearish divergence). Negative divergence signals that the price may soon start falling to lower levels. It also has two sub-types:
i) Regular Bearish divergence
ii) Hidden Bearish divergence
Some exhibits of Bearish divergence:
Exhibit 1: Regular bearish divergence
Exhibit 2: Hidden bearish divergence
Exhibit 3: Bearish divergence followed by a subsequent reversal
Thanks for reading! Hope this was useful.
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