Divergence and convergence is the discrepancy between the indicator and the price on the chart. These signals may indicate a weakening of the current trend or its reversal. Divergence is a bearish discrepancy, whereas convergence is a bullish one.
Types of Divergence
A classic bearish divergence is formed during the uptrend when a new maximum of the price curve is not confirmed by the corresponding movement on the indicator chart. It means the current trend is losing its strength. This is the right moment for opening a deal for sale. It is also recommended to close buy positions.
In case of a bullish divergence, at the next minimum of the price chart, the oscillator responds with a lack of progress. This means that it is time to buy and not to make deals for sale.
There are three types of divergence:
- Class A is considered to be the strongest one. It is usually a precursor to a rapid reversal.
- Class B is a medium divergence that can signal a trend weakening and its immediate correction.
- Class C is usually formed in markets with high volatility, so it is recommended to ignore it.
In addition to the classic divergence, there is also a hidden divergence that is a very strong confirmation of the current trend.
How to Use Indicators to Identify Divergence
To determine divergence, traders use indicators, trend lines or support/resistance levels. One of the most common tools used to detect divergences is the MACD indicator. As soon as the histogram transit from the positive to the negative, or vice versa, the signal is canceled. Another tool is the RSI oscillator. On its chart, overbought and oversold levels are displayed. All messages that are formed when the indicator is located in one of these areas are considered strong. Oversold and overbought levels are also present on the stochastic oscillator chart, so it can be used in the same way.
Some Tips from Traders
Before analyzing divergence and convergence in trading, traders make sure that there is a steady trend on the market. During the flat period, there can be a number of false signals. It is believed that the divergence is effective only on large timeframes, but practice shows that good results can be achieved in short segments as well. In order to determine the suitable period, it is highly recommended to polish skills on a demo account.