In technical analysis, convergence and divergence play a significant role. In fact, these patterns can identify potential reversal as well as continuation patterns. Today’s topic is based totally on how to trade Divergence and its various types.
Based on the three absolute of the market, price, volume, and time, divergence forms. Both convergence and divergence are widely used to predict future price action based on current values. It not only predicts future behavior but also determines current market movements. In this article, you will be introduced to the basic theory of the Divergence pattern. At the end of the post, I shall give you the link to download an AmiBroker AFL, AmiBroker being the World’s best charting tool, divergence.
What is a Divergence?
The term itself carries its meaning, ‘Divergence’ refers to separation or parting. Basically, the method belongs to the trend reversal and continuation pattern. Divergence exists when price action does not agree with a technical indicator. This disagreement happens only at a reverse or continuation position, the position can be bullish or bearish. Here price moves in one direction and the indicator in the other. Generally, oscillating indicators are widely used to identify a divergence pattern, for example, RSI, MACD, Stochastics, etc.
Types of Divergence Patterns to Trade
We are now going to explore different types of Divergence patterns. If we broadly classify the pattern, we will get two segments, Regular or Classic Divergence, and Hidden Divergence. Regular consists of Bearish divergence and Bullish divergence while Hidden consists of Hidden bullish divergence and Hidden bearish divergence. Let’s explore these types here. In order to explain the different patterns, I am going to take the support of the RSI oscillator but you can choose your oscillating indicator as per your wish. There is no specific rule that you have to use only RSI to identify the divergence pattern.
Bullish Regular Divergence
This divergence pattern typically forms near the end of a downtrend and it reverses it with the uptrend. Here the price action establishes a lower low while RSI or any oscillating tool forms a higher low. In order to understand the formation clearly, I have attached an image below:
Here, from the above image, it is clear that the formation is a classic bullish divergence, there is a high possibility of a bullish reverse trend after the divergence.
Bearish Regular Divergence
It comes prior to a downtrend or at the end of an uptrend. It is exactly the opposite of classical or regular bullish divergence form. In this formation, the oscillating indicator makes a lower high pattern while the price action establishes a higher high. The market tends to go down after the divergence.
As you can notice in the above formation a bearish trend appears at the end of the divergence. The disagreement between price and indicator is obvious here.
Bullish Hidden Divergence
Before stepping into the main discussion of what the hidden bullish divergence is, let’s have a look at the image of it so that the concept will be clear to you.
At a glance, you may be noticed that both the price action and the indicator is in an upward direction but if you look closer, you can see that the indicator’s bottom makes a downward move. Therefore, in this case, the price action makes a higher low while the indicators make a hidden lower low. As you can see at the end of the formation, the market tends to go upward direction. The hidden bullish is a continuation bullish divergence pattern.
Bearish Hidden Divergence
It is exactly the reverse pattern of hidden bullish divergence. Before proceeding, let’s have a look at the given image below:
This trade divergence forms a bearish reversal trend where the bearish trend continuation happens. The price action makes a lower high while the indicator completes a higher high. It continues the bearish trend. Therefore, the basic distinction between hidden and regular divergence is the regular one is a reversal pattern while hidden is a continuation divergence pattern.
Download AmiBroker AFL to Detect and Trade Divergence Patterns
You can download an AmiBroker AFL for divergence detection of the RSI Indicator from here. Check the image below to understand what the indicator looks like.
FAQs on Taking a Trade Based on Divergence
Divergence in trading occurs when the price of a security and the associated technical indicator move in different directions. For example, if the price increases but the corresponding oscillator decreases or vice versa then it indicates that there is divergence between them.
Yes, spotting trading divergences can be used as a successful trader strategy to identify reversal points and potential trend changes. It’s important to analyze all aspects carefully before confirming any analysis so that you make informed decisions when deciding whether to enter or exit trades.
The three types of divergences commonly seen in Indian stock market trading include regular bullish/bearish divergences, hidden bullish/bearish divergences, and extreme bearish/bullish convergences. Each one has its own advantages depending on how they’re applied correctly during your investment journey.
To spot and trade divergence successfully requires running different indicators such as moving averages (MA), relative strength index (RSI), MACD, stochastic oscillator, etc, on your chosen asset class charting platform to compare against more traditional fundamental methods such as gauging demand & supply mentality similar stocks movements- this will help you confirm true reversals or potential trend changes for best long term profitability assurance!
Hence, these are some basic concepts to know about divergence. We have discussed regular as well as hidden divergence patterns too. These patterns are helpful as a continuation as well as reversal patterns. You can follow the pattern in the trade as it is widely noticeable in technical analysis. If you use AmiBroker software, here we provide you with the link to download Amibroker AFL for this. From the link above, you can also download an AmiBroker AFL to trade the divergence patterns.