Charts and indicatorsUpdated 2 min readBy the FXNOD team
Divergence trading: regular, hidden and how to use it
Divergence is a disagreement between the price and a momentum indicator such as RSI or MACD. If the price makes a higher high while the indicator makes a lower high, momentum is weakening: a bearish divergence. It is a warning that a move is tiring. It gives no timing, and can continue for a long time before the price turns.
The four types
| Type | Price | Indicator | Suggests |
|---|---|---|---|
| Regular bearish | Higher high | Lower high | The uptrend is losing strength |
| Regular bullish | Lower low | Higher low | The downtrend is losing strength |
| Hidden bullish | Higher low | Lower low | The uptrend is likely to continue |
| Hidden bearish | Lower high | Higher high | The downtrend is likely to continue |
Regular divergence hints at reversal. Hidden divergence hints at continuation after a pullback.
How to spot it
Find two clear swing points in price
Two highs or two lows.
Compare the indicator at the same two moments
Join its peaks or troughs with a line.
Check the slopes
If the lines slope in opposite directions, there is divergence.
The timing problem
In a strong trend, divergence appears early and repeats. A market can print three or four bearish divergences while climbing, and each one stops out a trader who sold. Divergence tells you momentum has slowed compared with the last push. A slower climb is still a climb.
Using it without being run over
- Treat it as a reason to stop adding to a position, or to tighten a stop.
- For a reversal trade, wait for the price to confirm: a break of structure or of a trendline.
- Give more weight to divergence at a major level on a higher timeframe.
- Hidden divergence in the direction of the trend is the more forgiving trade.
Why it appears so often
Oscillators are bounded or mean-reverting by construction. A second price high that is only slightly higher will usually come with a lower indicator reading, simply because the second push was smaller. Divergence is common for that reason, and common signals are weak signals.
On synthetic indices
Divergence will appear constantly on a random series. It reflects how the indicator is calculated, and has no meaning for the next move.
Questions people ask
- Which indicator is best for divergence?
- RSI and MACD are the most used. The choice matters less than waiting for the price to confirm.
- Is divergence a reliable signal?
- As a warning, moderately. As a timing signal, no: it can persist through a long trend.
- What is hidden divergence?
- Price makes a higher low while the indicator makes a lower low, or the reverse in a downtrend. It suggests the trend will continue.
Put it on a chart
Trade Pilot's chart has moving averages, RSI and Bollinger Bands, and a bot in Bot Forge can use indicators to choose its side. Try both on your Deriv demo account.
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