Divergence Trading: How to Trade Bullish and Bearish Divergence Guide

Divergence is one of the common uses of many technical indicators, primarily the oscillators. We have a basic stock trading course, swing trading course, 2 day trading courses, 2 options courses, 2 candlesticks courses, and broker courses to help you get started. We will help to challenge your ideas, skills, and perceptions of the stock market. Every day people join our community and we welcome them with open arms. We are much more than just a place to learn how to trade stocks.

Engaging in divergence trading relies on the use of indicators or oscillators to detect specific price movements in assets. As previously mentioned, these indicators unveil instances of divergence, enabling traders to base their decisions on the analysis provided by these tools. Consequently, when an indicator reveals a divergence, it serves as a potential warning sign for a price reversal in the actual market. The primary principle underlying the analysis of divergences when making trading decisions is that indicators or oscillators signal a potential reversal in the current price trend. Consequently, divergences assist in forecasting future market prices, aiding traders in making well-informed trading choices. To confirm divergence effectively, connect the highs or lows on the price chart and on the indicator, ensuring they align.

  1. Avoid risking more than you can afford to lose on a single trade.
  2. Divergence occurs when the price and indicator move in opposite directions, indicating a potential trend reversal.
  3. Regular divergences are further divided into subcategories regular bullish divergence and regular bearish divergence.
  4. There are two types of divergence on the chart – bullish and bearish.

We’ll dive headfirst into understanding its significance in technical analysis and how it can give you an edge in the competitive trading world. As we can see from the above daily chart of JSW Steel, one can easily trade by analyzing bullish and bearish patterns. Simply put, divergences occur when a price moves in one direction while another indicator—typically an oscillating indicator—moves in a different direction. Here, we’ll examine how to assess price momentum and demonstrate what trading this pattern in momentum can reveal about a trend’s direction.

FAQs about divergence trading

Arbitrage is when an asset is bought and sold at the same time, in different markets, to take advantage of a temporary price difference. This situation takes advantage of inefficiencies in the market. Theoretically, convergence happens because an efficient market won’t allow something to trade for two prices at the same time.

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Bear in mind that divergence only indicates a loss of momentum, but it doesn’t necessarily signal a trend shift. Acting on divergence alone can lead to substantial losses if the anticipated price reversal doesn’t occur accurate currency strength meter soon enough or at all. Many traders have gotten bad results when they trade with divergences only. Similar to other trading strategies, you should try to get a stronger confirmation by adding more confluence factors.

Example of Bullish Divergence with OBV:

Also known as the 60-minute strategy, this technique uses both Momentum trading and Bollinger Bands strategies. Momentum trading is when you buy securities rising and sell them when they look to have peaked. If bulls can somehow manage to stop the bleeding, your RSI is already overbought and that will cut the run short.

If the price is making higher highs, the oscillator should also be making higher highs. If the price is making lower lows, the oscillator should also be making lower lows. At the same time, we place a stop loss order above the top created before the reversal. The RSI gives a sell signal, when the line goes in the overbought zone above 70.

So, 2024 doesn’t appear to be a year in which Nvidia slows down. It was a strong year overall for the stock markets, with leading indexes like the S&P 500 rising by 24% during the period. However, The Magnificent Seven substantially outpaced most others as tech titans more than doubled overall. The Magnificent 7 stocks dominated the stock market and investing headlines throughout 2023. It will be remembered as the year artificial intelligence took off, resulting in massive growth.

Divergence is a strategy used in technical analysis that occurs when the asset price moves away from a technical indicator. Divergence signals that the current price trend is weakening and that a reversal may ensue. A negative divergence occurs when an asset’s price is in an uptrend while the indicator is moving lower. Conversely, positive divergence happens when the price is in a downtrend, but the oscillator is moving higher.

In the world of online trading, success does not just depend on market knowledge or technical analysis, but significantly on the trader’s… (1) When the RSI makes similar highs during an uptrend it means that the momentum of the trend is unchanged. When the RSI makes an equal high, it does not qualify as a divergence because it just means that the strength of the uptrend is still up and stable. A divergence forms on your chart when price makes a higher high, but the indicator you are using makes a lower high. In my own trading strategy, divergences are a big part for one of my setups and in combination with other signals.

You can reduce your chances of getting whipsawed too often by only trading divergence that occurs on the daily timeframe. The likelihood of a reversal increases when more timeframes show divergence between price and momentum. There is no best timeframe for trading divergence, but generally, in shorter timeframes, divergence signals occur more frequently and are less reliable.

What Does Divergence Mean in Trading?

We introduce people to the world of trading currencies, both fiat and crypto, through our non-drowsy educational content and tools. We’re also a community of traders that support each other on our daily trading journey. So you’ve connected either two tops or two bottoms with a trend line. Now look at your preferred technical indicator and compare it to price action.

Convergence occurs because the market won’t allow something to trade for two prices simultaneously. If, however, there are significant differences between the price of the futures contract and the underlying security, a risk-free arbitrage opportunity will present itself. Yet, risk-free arbitrage opportunities rarely exist because the futures contract price converges toward the cash price as the delivery date approaches. Longer upward swings indicate that momentum is rising, while shorter upswings signal weakening momentum and trend strength. Finally, equal-length upswings demonstrate the momentum has remained unchanged. Taking profit or selling a call option were fine strategies in Figure 5.

The Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), and Stochastic Oscillator are some of the most popular technical indicators traders use. Cheat sheets for these indicators provide a quick reference guide to identify divergence. Many types of divergence cheat sheets are available, each with unique features and benefits. Usually, the RSI oscillator has made higher highs while prices have continued to decline and have formed lower highs. This kind of divergence is mostly with normal pullbacks in a trend and indicates that a pullback is about to reverse for the trend to continue.