Divergence

Definition

A divergence occurs when an asset’s price is moving opposite to a specific technical indicator or is moving in a different direction from other relevant data. The divergence indicator warns traders and technical analysts of changes in a price trend, oftentimes that it is weakening or changing direction.

Divergence can be either positive, signifying the possibility of a move that is higher in the asset’s price, or it can be negative, signifying the possibility of a move that is lower in the asset’s price.

Takeaways

Divergence often works with other indicators and data. It is usually used by technical analysts and traders when the asset’s price is moving counter to the direction of another indicator.

As mentioned above, positive divergence indicates that the price could start rising and usually occurs when the price is moving lower, but while another indicator counters this direction by moving higher. In other words, showing bullish signals.

Negative divergence indicates that the price could start declining and usually occurs when the price is moving higher, while another indicator moves lower as well. In other words, showing bearish signals.

What to look for

Divergence is most often used to track and analyze the momentum in an asset’s price and the odds of a price reversal within the current trend. While using divergence, traders and analysts can decide on whether or not they would like to exit the position or set a stop loss in the case the divergence is negative and prices begin to fall.

Limitations

It is best to use divergence with the aid of other indicators and analysis tools in order to help identify and confirm trend reversals and major market patterns. Divergence should not be relied on by itself to tell you the pertinent information you need to know as an investor. Risk control is key in your analysis and the fact that divergence is not always present in price reversals should definitely be what pushes you to combine it with other tools and indicators.

Additionally, divergence can reflect long-term or short-term changes. When making snap decisions, acting on divergence alone could prove detrimental to your trading. Make sure you have other risk factors applied to your charting and general market analysis.

Summary

The divergence indicator helps traders assess changes in the price trend and indicates when price will move with or against the direction of another indicator. It can be either positive or negative, but it is important to note its limitations and that it should be used with other indicators that can also monitor price trends. 

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