The Ultimate Divergence Cheat Sheet: A Comprehensive Guide for Traders

Yes, we work hard every day to teach day trading, swing trading, options futures, scalping, and all that fun trading stuff. But we also like ether trader to teach you what’s beneath the Foundation of the stock market. We don’t care what your motivation is to get training in the stock market.

  1. Divergence tells the traders something is changing, suggesting a possible redirection in strategy, such as tightening the stop-loss or taking a profit.
  2. Have you ever wondered why a stock will continue higher, even though the indicators are all rolling over?
  3. You are now looking at the 10-minute chart of Netflix from Aug 16-23, 2016.
  4. Divergences on shorter time frames will occur more frequently but are less reliable.

If you wish to learn more about divergence trading, you must explore the Price Action Trading Strategies. This comprehensive course will help you build a strong foundation in price action trading. This course will help you learn to spot and trade the most important trading patterns, that is, double tops/double bottoms, triple tops/triple bottoms, head and shoulders. To excel in divergence trading, traders should combine divergence analysis with other technical and fundamental analysis tools, maintain discipline, and manage risk effectively. Avoiding these common mistakes is crucial for achieving success in this strategy. On the other hand, hidden divergence generally focuses on trend continuation, and its identification involves patterns opposite to regular divergence.

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By combining technical analysis tools, traders can confirm potential trends and reduce the risk of false signals. For example, traders can use support and resistance levels, moving averages, and trendlines to confirm potential divergence signals. Combining different technical analysis tools can also provide a more comprehensive market picture and help traders make more informed trading decisions. One of the primary disadvantages of relying solely on divergence cheat sheets is the risk of false signals. False signals can occur when a temporary blip in the price or technical indicator does not represent a significant trend change. Relying solely on divergence cheat sheets can also lead to missed opportunities, as traders may overlook other important technical analysis signals.

The market made a reasonable downswing that would have yielded a nice profit. In summary, understanding divergence in trading empowers traders with valuable insights into market trends, risk management, and entry/exit timing. It adds a layer of confirmation and versatility to trading strategies, ultimately contributing to more informed and successful trading decisions. Moreover, we’ll provide practical insights into using both regular and hidden divergences to your advantage.

In summary, regular divergence aims to identify potential trend reversals, making it suitable for traders looking to catch turning points in the market. Hidden divergence, on the other hand, helps traders recognise trend continuation opportunities, allowing them to stay in the direction of the prevailing trend. Both strategies require proper risk management and adherence to trading plans. Traders use divergence to assess the underlying momentum in the price of an asset, and for assessing the likelihood of a price reversal. For example, investors can plot oscillators, like the Relative Strength Index (RSI), on a price chart.

Difference between trading with regular divergence and hidden divergence

If the fast line crosses the slow line in an upward direction, it’s a sign of a bullish divergence. Conversely, if the fast line crosses in a downward direction, you have a bearish divergence. A bullish signal occurs when the MACD line is going up while the price is going down. If the MACD line is going down and the price is rising, it’s an indication of a bearish divergence. To avoid trade entries that don’t go anywhere, I highly suggest you add other criteria and confirmation tools to your arsenal. A divergence alone is not something that strong enough and many traders experience bad results when trading only with divergences.

Types of divergence trading

In case the indicator goes above 70, it implies that the market is overbought (it is a good time to sell) and may correct itself by going down. When the value of an asset, indicator, or index moves, the related asset, indicator, or index moves in the other direction. When bullish divergence occurs, the lows in MACD are rising while the price continues to fall. A momentum oscillator, that gauges the direction and power behind price movements. It is most often used as a measure of being “overbought” or “oversold”. RSI calculates based on the candle close, which is why candle bodies are used rather than candle wicks to determine divergence.

With this oscillator, convergence happens in case the moving averages move closer to each other, conversely, divergence happens in case the moving averages move away. Moreover, the Indicator is above 0 when the 12-period EMA (shorter period) is above 26-period EMA (longer period). Whereas, it is below 0 when the shorter 12-period EMA is below the longer 26-period EMA.

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This could come in the form of a trading strategy that allows you to identify lucrative opportunities, even in turbulent market conditions. One such strategy that has grown in popularity among traders is utilizing divergence. Divergence is an effective method that can offer traders significant insights into market trends and potential price reversals. Divergence indicators such as the Moving Average Convergence Divergence (MACD), the Stochastic Oscillator, and the Relative Strength Index (RSI) are commonly used.

When that doesn’t happen, the price’s swing high or low and the oscillator’s high or low would be out of phase, and we have a divergence. As you can see in the images below, an oscillator shows a divergence (movement in opposite direction) from the actual price trend in the market. It is used to describe the phenomenon of the futures price and the cash price of the underlying commodity moving closer together over time. In most cases, traders refer to convergence as a way to describe the price action of a futures contract. We confirm a hidden bearish divergence when the price shows lower tops, and the indicator gives higher tops. Hidden bearish divergence occurs when the oscillator continues to make lower lows, but the price action does not, and instead begins to consolidate.

Divergence can have significant implications for trade management. The amount of divergence is relative, so several patterns can develop in the relationship between the price and an indicator. Disagreement between the indicator and price is called divergence.

Whereas, below 20, it indicates that the price is oversold and it is a good time to buy. As we journey through this topic, you’ll discover intriguing facts about divergence trading, including historical instances where it led to significant returns. We’ll also highlight common pitfalls to avoid, ensuring you trade with confidence and precision. Asktraders is a free website that is supported by our advertising partners. As such we may earn a commision when you make a purchase after following a link from our website. Here, you can see Litecoin on the daily chart from back in December of 2019.

On the other hand, in higher timeframes, divergence signals occur less frequently but are more reliable — the higher the timeframe the more valid and stronger the signal. This type of divergence occurs when the price is making a higher swing high while the indicator is making a lower high. It occurs mostly when the price has been in an uptrend for a long time, and it gives a bearish reversal signal. Suddenly, the price action breaks the pink bearish trend line with the opening bell on Aug 23, 2016. This is a strong price action signal that the trend might change direction. CCI, or Commodity Channel Index, was developed as a commodity trading indicator, but it’s now widely used in stock trading as well.

At the point that momentum wanes, you then scale out of the position by taking progressive profits on your fractional trades. The second divergence trade did not do much from a pip perspective. Nevertheless, a very significant top was undoubtedly signaled with this second divergence, just as a bottom was signaled with the first divergence trade. The second divergence signal (seen in dark blue), which occurred between mid-December 2006 and mid-January 2007, was not quite a textbook signal. In other words, the price portion of this second divergence did not have a delineation that was nearly as good in its peaks as the first divergence had in its clear-cut troughs. This type of divergence signifies that a bearish trend will go down and a possible downward reversal is likely to happen.