Price Divergence (Divergence) - An Essential Tool for Traders

What is Bearish divergence and how does it relate to downward price trends

Bearish divergence in trading refers to a situation where the market price continues to rise higher, but the signals from technical analysis tools (indicate) a negative or weak signal. This contradiction reflects that the upward trend may be losing momentum, and the price is warning of a potential large correction.

The important thing to remember is that divergence does not mean the analysis tools are useless, but rather that they are communicating information that differs from normal signals. This creates four possible scenarios that traders need to be aware of.

How to recognize if (Divergence) is occurring

Scenario 1: Fake Bullish Trend (Bullish Divergence)

When the market drops sharply but the indicator does not confirm, it may not follow the downward move or may start to rise. This situation indicates that the downward momentum is weakening, and the price could reverse to an uptrend.

Scenario 2: Fake Bearish Trend (Bearish Divergence)

When the market continues to rise but the indicator does not show the same, the analysis tools do not follow through or start to decline. This contradiction suggests that the upward momentum is fading, and a correction may be imminent.

Scenario 3: Hidden Bearish Divergence (Hidden Bearish Divergence)

The price has already moved down, but the indicator does not show weakness. On the contrary, it still signals a strong downward trend. This scenario indicates that the downward movement will likely continue.

Scenario 4: Hidden Bullish Divergence (Hidden Bullish Divergence)

The price has already moved up, but the indicator does not show weakness. Instead, it signals a strong upward trend. This situation suggests that the price may continue to move higher.

Which tools are good for spotting (Divergence)

Most traders prefer to use oscillator tools because they clearly indicate the strength of price movements. Examples include:

MACD combines two moving averages. When MACD shows positive values and increases, it indicates an uptrend. Negative values and decreasing suggest a downtrend. Divergence occurs when the price makes new highs but MACD does not follow.

RSI or Relative Strength Index is often used to identify overbought (more than 70) or oversold (less than 30) conditions. Divergence in RSI that does not confirm the price movement in these zones is a sign of potential reversal.

Williams %R operates similarly to RSI, indicating overbought (>80) and oversold (<20) levels. Divergence in these areas is also a key observation point for traders.

The difference between natural and hidden signals

Traders should be able to distinguish which divergence indicates a trend reversal and which suggests the current trend will continue. This classification is crucial for your trading fate.

Regular Divergence - Main Signal

Regular Divergence is a clear conflicting signal that occurs when the trend makes higher highs or lower lows, but the indicator does not confirm the strength. This suggests a possible trend reversal (Reversal).

Bullish Divergence occurs when the price makes a new low, but the indicator does not follow or starts to rise. This indicates the selling pressure is waning, and a strong upward move may follow.

Bearish Divergence occurs when the price makes a new high, but the indicator does not confirm or starts to decline. This signals the upward momentum is weakening, and a sharp drop could happen soon.

How to trade Regular Divergence:

• Look for chart patterns like eggs, stars, etc., near potential reversal points.
• Observe if the indicator enters overbought or oversold zones without confirmation from the price.
• Wait for price signals such as Hammer or Shooting Star candlesticks indicating reversal.
• Enter a position in the opposite direction, with a Stop Loss set at the previous level.

Hidden Divergence - Concealed Signal

Hidden Divergence appears when the price swings weakly, but the indicator does not show signs of weakness. Conversely, it still indicates the current trend has strength (Continuous Pattern).

Hidden Bullish Divergence occurs when the price swings up with less force (higher than the previous peak), but the indicator shows a lower low (Lower Low). This suggests the uptrend will continue.

Hidden Bearish Divergence occurs when the price swings down with less force ###lower than the previous trough###, but the indicator shows a higher high ###Higher High(. This indicates the downtrend is still intact.

How to trade Hidden Divergence:

• Identify price patterns with weak swings up/down, but indicators do not show weakening.
• Confirm that the existing trend still has momentum.
• When the price breaks out in the direction of the trend, follow the trend.
• Set Stop Loss at the highest/lowest point of the swing.

Examples of trading Divergence from real markets

) Case of Regular Bullish Divergence Imagine the market has been falling, making new lows and entering the Oversold zone with RSI below 30. Then, the price drops again to a new low, but RSI does not reach the oversold zone like before. This is a Bullish Divergence signal indicating the selling pressure is ending. When a large green candlestick appears afterward, traders can buy with a Stop Loss below the recent low.

( Case of Regular Bearish Divergence The price has been rising, making new highs and entering the Overbought zone with RSI above 70. Then, the price makes another new high, but RSI does not reach the overbought zone as before. This signals a Bearish Divergence, suggesting the upward momentum is waning. When a red candlestick with a Shooting Star pattern appears, traders can short with a Stop Loss above the recent high.

) Case of Hidden Bullish Divergence The price gradually rises within the normal RSI zone (30-70), with minor dips creating higher lows ###Higher Low(, while RSI forms lower lows )Lower Low(. This is Hidden Bullish Divergence, indicating the uptrend will continue. When the price breaks above the upper boundary, traders can follow the trend.

) Case of Hidden Bearish Divergence The price gradually declines within the normal zone, with minor upward swings creating lower highs $100 Lower High, while RSI forms higher highs Higher High. This is Hidden Bearish Divergence, signaling the downtrend will persist. When the price breaks below the lower boundary, traders can follow the trend.

Important precautions

Although divergence is a useful tool, it is not perfect. Sometimes, the price may form divergence multiple times before the actual signal occurs. Therefore, traders should use divergence in conjunction with other tools such as Support/Resistance or candlestick patterns.

Additionally, setting appropriate Stop Loss and Take Profit levels is always important. Even if divergence is observed, risk management is essential to protect yourself.

Summary

Divergence is a technical analysis tool that helps traders identify weaknesses in the current trend or confirm that the trend will continue. Whether it’s Regular Divergence indicating a reversal or Hidden Divergence indicating continuation, understanding and proper application—along with risk management—can make divergence a profitable part of your trading strategy.

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Warning: Derivatives may involve high risk and could result in losing all your capital. Please read the risk disclosure document carefully before making any decisions. Presented by Mitrade Holding Ltd. SIB License 1612446