Summary on divergences

A divergence is spotted when price movement in a trend disagrees with the underlying momentum indicator. As price makes higher highs, the momentum indicator makes lower highs.

When there is a difference in the movement of indicators and prices, it shows a potential change in price momentum that may result to a change in the direction of the trend.

Some of the commonly used momentum indicators are MACD, RSI and Stochastic

Divergences appear in three different types

 Regular divergences

Hidden divergences

Exaggerated divergences

Regular divergences

When price action hits higher highs or lower lows when momentum oscillators are not doing the same. For example when price is making a higher high and the indicator is showing a lower high or price makes lower lows and momentum makes higher lows.

For an uptrend, if price is making higher highs and the oscillator makes lower highs, this is a regular bearish divergence

When price has achieved its lower low and the oscillator fails by making higher lows, there is a disagreement between the two which makes it a regular bullish divergence.

Hidden divergences

Hidden divergences are not strong reversal points. They may shift the trend for some time and then the trend continues in its direction or causes no change at all. They also appear in two forms;

Hidden bearish divergences

A correction appears during a downtrend as the oscillator strikes higher high and price only afford lower high or maintains its previous point. This indicates that the trend is still strong and may continue its direction after the completion of the consolidation.

Hidden bullish divergence

This forms during an uptrend. As the oscillators make lower lows, price only affords the higher lows or maintains its previous points for a consolidation. The trend is likely to continue after a while.

The exaggerated bearish divergence

This where price forms two tops almost at the same line but the indicator diverges and its second top is lower than the first one. It gives an indication that the downtrend is still strong.  You can either open a new short position or continue holding your short position

Exaggerated bullish divergence

The exaggerated bullish form when price form two bottoms almost same level as the indicator forms bottoms with the second one higher than the first. It gives a signal for a strong continuation of an uptrend .when this appears, you can either continue holding your open long position or open a new position.

Trading divergences is like trading any other strategy. It also has its short comings because like we said indicators are known to give fake signals most times especially on a smaller timeframe.  Always look at a bigger time frame version and make use of other technical tools and candlesticks to come up with a strong judgment.

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