What is divergence based trading ?

Divergence-based trading is a strategy used in technical analysis where traders look for discrepancies between the price movement of an asset and an indicator (like the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), or Stochastic Oscillator). These discrepancies, or "divergences," can signal potential changes in the direction of the price trend.

There are two main types of divergences:

1. **Regular Divergence**: This occurs when the price forms a new high or low, but the indicator fails to confirm it by making a lower high or higher low, respectively. It can signal a reversal of the current trend.
- **Bullish Divergence**: When the price makes a lower low, but the indicator makes a higher low, suggesting the downtrend may be weakening and a reversal to the upside could be coming.
- **Bearish Divergence**: When the price makes a higher high, but the indicator makes a lower high, suggesting the uptrend may be weakening and a reversal to the downside could be coming.

2. **Hidden Divergence**: This type of divergence occurs when the price fails to make a higher high or lower low, but the indicator still shows a higher high or lower low. It can signal the continuation of the current trend.
- **Bullish Hidden Divergence**: When the price makes a higher low, but the indicator makes a lower low, suggesting the uptrend may continue.
- **Bearish Hidden Divergence**: When the price makes a lower high, but the indicator makes a higher high, suggesting the downtrend may continue.

**How traders use divergence-based trading**:
- **Reversal trades**: Regular divergence is often used to spot potential reversals, with traders entering positions when they expect a change in trend.
- **Trend continuation**: Hidden divergence is used to confirm that the existing trend is likely to continue, so traders may look to enter trades in the direction of the current trend.

Divergence trading relies on the belief that price and indicators should align, and when they don't, it often signals a potential shift in market behavior. However, divergence alone isn’t always enough for making trading decisions, so traders often combine it with other tools like support and resistance levels, trendlines, or volume indicators for better accuracy.