Divergence Trading

Divergence occurs when price and a momentum indicator move in different directions or disagree about the strength of a move. Because momentum often shifts before price does, divergence is considered a leading signal that can flag an exhaustion or continuation before it becomes obvious on the price chart alone.

Regular (Reversal) Divergence

• ▸Bearish regular divergence: price makes a higher high, but the oscillator makes a lower high — upward momentum is fading.
• ▸Bullish regular divergence: price makes a lower low, but the oscillator makes a higher low — downward momentum is fading.

Regular divergence warns that the current trend may be losing steam and is often watched for near the end of extended moves, though it can persist for a while before price actually turns.

Hidden (Continuation) Divergence

• ▸Bullish hidden divergence: price makes a higher low, but the oscillator makes a lower low — the uptrend's pullback is weaker than it looks.
• ▸Bearish hidden divergence: price makes a lower high, but the oscillator makes a higher high — the downtrend's bounce is weaker than it looks.

Hidden divergence is used by trend-following traders as a signal that a pullback is likely to fail and the dominant trend is likely to resume — the opposite implication of regular divergence.

Common Indicators for Divergence

RSI and MACD are the two most commonly used oscillators for spotting divergence, though stochastic and CCI work similarly. The principle is the same across all of them: compare the swing highs/lows of price to the corresponding swing highs/lows of the oscillator.

Confirming a Divergence Signal

1. 1.Wait for a price-action confirmation, such as a break of a short-term trendline or a reversal candlestick pattern.
2. 2.Check whether the divergence appears at a significant support/resistance level for added confluence.
3. 3.Consider the higher-timeframe trend — regular divergence against a very strong trend is riskier to trade than divergence within a range or weaker trend.