Contents
Divergence? Bullish divergence? Hidden bullish divergence? We will explain all these terms in a moment. This guide is written to help traders use divergences in order to find the best entry points. After reading it, you will know what divergence means, what the difference between the classic and hidden divergence is, and how to use them in trading.
Key Takeaways🔑
| →Divergences can help traders identify potential trend reversals or continuations. |
| →Classic divergences signal a possible trend reversal, while hidden divergences suggest trend continuation. |
| →Combining divergence analysis with other technical tools can help traders optimize their entry points. |
What is the divergence?
The divergence can be observed when you are using an oscillator on your chart. It can be, for instance, the Relative Strength Index, the Moving Average Convergence Divergence, the Stochastic Oscillator, or the Commodity Channel Index.
The difference in the movements of the oscillator and the price of the underlying financial instrument is called the divergence.
There are two kinds of divergences identified in the trading world. The classic and the hidden divergence.
The types of divergences
As I have already mentioned, we distinguish the classic and the hidden divergence. Moreover, each type can be further divided into bearish and bullish ones.
The regular divergence says that the trend is getting weaker and will most probably reverse. The classic divergence is spotted when the price creates lower lows or higher highs on the chart but the oscillator is not displaying the same movement.
The hidden divergence, on the other hand, indicates that the price consolidates or makes a correction inside the present trend and soon will continue in the previous direction. The hidden divergence occurs when the indicator creates lower lows or higher highs, but the price action does not show the same.
Bearish divergences
The classic bearish divergence takes place during the rise of the prices. It is also called negative divergence. The price action forms higher highs but the indicator does not affirm such a movement. It creates lower highs or double or triple tops instead.
The hidden bearish divergence appears during the downtrend. The higher highs are created by the oscillator line. Price action, however, does not make the same.
An example of bearish classic divergence
Below, you will find the exemplary chart for the bearish classic divergence. The price is rising and forms higher highs. But the RSI line is falling at the same time. This is the divergence and a signal that the trend will soon reverse.
An example of bearish hidden divergence
The next chart presents the bearish hidden divergence which occurs during the downtrend. The indicator creates higher highs but the price is clearly falling. This is a hidden divergence which announces that the previous price direction will be soon continued.
Bullish divergences
The classic bullish (or positive) divergence can be noticed when there is a downtrend in the market. The price action forms lower lows, and the indicator does not. It can create higher lows or double or triple bottoms.
The hidden bullish divergence develops while there is an uptrend in the market. The oscillator makes lower lows. The price action does not confirm the same movement.
An example of bullish classic divergence
Below, there is the AUDUSD currency pair chart with bullish classic divergence. The price is falling and creating lower lows. At the same time, the indicator is forming higher lows. This is a trend reversal pattern.
Pros and Cons of Divergence Trading📊
- Pros: 💡
- Can help traders identify potential trend reversals or continuations.
- Applicable to various financial instruments and timeframes.
- Can be combined with other technical analysis tools for improved accuracy.
- Cons: ❗️
- May generate false signals if used alone.
- Does not provide precise entry or exit points.
- Effectiveness can vary depending on market conditions and the chosen oscillator.
| Oscillator | Key Features |
|---|---|
| Relative Strength Index (RSI) | Measures the speed and change of price movements; popular for identifying overbought and oversold conditions. |
| Moving Average Convergence Divergence (MACD) | Tracks the relationship between two moving averages; helps identify trend direction and potential reversals. |
| Stochastic Oscillator | Compares a security's closing price to its price range over a given time period; useful for identifying overbought and oversold levels. |
| Commodity Channel Index (CCI) | Measures the deviation of the current price from its average price; helps identify trends and potential reversals. |
How do you find hidden bullish divergence?
By contrast, the bullish hidden divergence serves as a continuation pattern. It takes place during the uptrend and you can see below that the RSI creates lower lows while the price action forms higher lows at the same time.
Using the divergences in trading on the IQ Option platform
The divergences give information about the expected price direction. Classic divergences announce the possible reverse in the trend and the hidden ones the continuation of the former trend.
Divergences themselves do not reveal the exact moment to open the trade. This is the reason why they are commonly supported by additional tools such as candlestick patterns, chart patterns or simply the trendlines. You may use as well the Bollinger Bands or envelopes together with the divergences.
When the bearish divergence appears near the resistance trendline or there is a bearish reversal pattern in the uptrend, it becomes more significant.
Similarly, the bullish divergence is more meaningful when it appears near the support trendline or when there is a bullish reversal pattern on the price fall.
Remember that hidden divergences work best in a trend. So if you are looking for a hidden bullish divergence, for example, make sure that your chart is dominated by an uptrend.
Conclusion
The difference in the movements of the indicator and price action is called the divergence. There are two kinds of divergences. One is known as a classic or regular divergence and the other one as a hidden divergence. Both can be bearish or bullish.
Use additional techniques to get the best entry points for your trades.
Try to catch the classic and hidden divergences in the IQ Option demo account. It does not cost you anything. And you can practice trading with divergences as long as you wish.
I would be glad to hear your opinion about the divergences in trading. Kindly use the comments section below to share your thoughts with us.
Good luck!
Q&A: Common Divergence Trading Questions 🎯
- Q: Can divergence trading be used for both short-term and long-term trading?
- A: Yes, divergence trading can be applied to various timeframes and trading styles, including short-term and long-term trading.
- Q: Is divergence trading only applicable to certain financial instruments?
- A: No, divergence trading can be used with a variety of financial instruments, such as stocks, forex, commodities, and indices.
- Q: Can divergence trading be used in conjunction with other technical analysis tools?
- A: Absolutely. Combining divergence trading with other technical analysis tools can help improve the accuracy of your trading signals.
- Q: How can I avoid false signals when using divergence trading?
- A: To minimize false signals, consider using additional technical tools, such as support and resistance levels, trendlines, and candlestick patterns, to confirm the divergence signal.
- Q: Which oscillator is best for divergence trading?
- A: There is no one-size-fits-all answer, as the effectiveness of an oscillator for divergence trading can depend on your trading style, time frame, and the specific market conditions. Experiment with different oscillators to find the one that works best for you.