While both types of divergence serve as reversal signals, they apply to opposite market conditions. Bullish divergence is when there is upward movement following a downward trend, and bearish divergence when there is downward movement after an upward trend. This trading method does not provide a clear price level to place a stop loss like other chart patterns such as the butterfly pattern or the double bottom chart pattern.

• In addition to spotting a divergence signal, you can also use the MACD to see the continuation of the market movement trend when the line is near the oversold or overbought area.
• It is relevant for crypto assets, currency pairs, stocks, and other trading instruments.
• The emergence of a divergence pattern can signify whether a trend will continue, weaken, or reverse.
• When we see an MACD crossover in the opposite direction, we will close our trades.
• Conversely, selling at or near a peak can feel like madness when the crowd insists that the market is on track for continuous gains.

A leading indicator can show the direction of the next price movement before it appears on the chart. They include the commodity channel index (CCI), Stochastic, Williams %R, moving average convergence divergence (MACD), and on-balance volume (OBV). A bullish divergence is defined on a chart when prices make new lower lows but a technical indicator that is an oscillator doesn’t make a new low at the same time. This is a signal that bearish sentiment is losing momentum with the high probability that buyers are stepping in and the market may be near a bottom on the chart’s time frame. In many instances a bullish divergence can be the key indication on a chart that signals the end of a downtrend and that the risk/reward ratio has shifted in the favor of the bulls. Typically, traders look for an opportunity to buy after spotting regular bullish divergence, aiming to benefit from the expected upward movement.

Divergence trading indicators

However, the best results come when divergence is spotted on higher time frames such as 4-hour sessions or higher. Note that divergence may form across more than two highs, meaning divergence may persist for a long time. As you can see in the chart above, the price didn’t experience an immediate change in momentum after divergence. It will cause the bearish trend to continue because of more sellers returning to the market.

Although no commandment guarantees results, balancing technical data with reasoned judgment can be a more reliable guide than market rumours or wild optimism. In the late 1990s, internet stocks exploded in value, mostly propelled by speculative fervour rather than solid earnings. While charts showed that momentum indicators were deteriorating, few wanted to believe the party would end. Thus, if an investor had read the technical signals combined with a watchful eye on the market’s overconfidence, they might have scaled back long positions or set tighter stops.

• Therefore, when prices are making higher highs or higher lows, the oscillator tends to mimic the same pattern.
• Other indicators that also can be used for divergence are CCI and ROC (price rate of change ROC).
• This form of divergence indicates that while the prices are moving upward, the bullish momentum is weakening or temporarily pausing and suggests a potential bearish reversal.
• These types of mistakes can happen with essentially any form of technical analysis.

As the name indicates, MACD is an indicator based on a moving average which can be used to compare two moving averages. You can understand why a price movement is getting stronger or weaker through these two moving average relations. When prices reverse or retrace, the oscillator tends to follow the same pattern.

Another momentum indicator, when is a bull flag invalidated it measures the flow of bullish and bearish volume to help draw a picture as to the strength or weakness of the underlying security. A momentum oscillator, that gauges the direction and power behind price movements. RSI calculates based on the candle close, which is why candle bodies are used rather than candle wicks to determine divergence.

Types of Divergences

Class C bullish divergences occur when prices fall to a new low while the indicator traces a double bottom. Class C divergences are most indicative of market stagnation—bulls and bears are becoming neither stronger nor weaker. Therefore, divergence trading can be used not only to time the entry into a trade within a trend, but it can also help you to understand support and resistance levels. This inclination can lead to heavy losses if an investor sells positions at rock-bottom prices. A more cool-headed approach might be to consult technical signals to see if momentum is improving.

We could use this signal to go long on our bullish divergence setup as shown with the green horizontal arrow. Our stop loss order should be located right below the last bottom as shown on the image. After a period of price increase, the Momentum Indicator starts recording lower top while price is making higher highs. This is a bearish divergence between the price action and the Momentum Indicator. Then, we see a large bearish candle, which breaks the Moving Average line between the bands. At the same time, the Bollinger Bands start expanding, indicating higher volatility.

What is a bearish divergence?

This is a telltale sign of a weakening bearish trend, indicating a bullish reversal might be on the horizon. Uncertainty fuels panic as participants justify selling at any price to avoid total ruin. In many instances, this blind rush to sell leads to extreme lows, paving the way for bullish divergence.

For Traders

One last thing to be aware of is normal price fluctuations can lead to false signals. Since bullish divergence occurs during a downtrend, it’s not uncommon to see the price just continue in the same direction, down. So timing is crucial – entering a trade too early based on this signal alone can lead to losses. Now that you know what to look for, you can apply that to your chart analysis and start hunting for these types of opportunities.

Regardless of the trading method you use, you should always use a Stop Loss order for each of your trades. And for axitrader review most traders, it is best to place a hard stop in the market instead using a mental stop. As far as the divergence setup goes, one way to place your stop loss would be put it right above the last top on the chart, which confirms the bearish divergence. If the divergence is bullish, then we rely on bottoms and the stop should be placed below the last bottom on the chart. We have discussed the types of divergence patterns and some reliable indicators to trade divergence with.

Bullish and Bearish Divergence FAQs

Thus, it should be used in conjunction with other technical indicators and risk management strategies. For instance, longer timeframes like the one-day chart 10 ideas for how to invest $5,000 in real estate today will have fewer occurrences of the RSI divergence. But, as there is less noise in larger timeframes, the divergence tends to be more reliable, offering a stronger signal to the traders.

There are two bullish divergence patterns, regular bullish divergence, and hidden bullish divergence. Hidden divergence signals are particularly valuable for traders as they provide early indications of trend continuation. This phenomenon suggests that while the price may exhibit temporary pullbacks or rebounds, the underlying momentum supporting the trend remains intact. Therefore, understanding hidden divergence empowers traders to better interpret market dynamics to make better trading decisions.

This type of divergence occurs at the end of a bearish trend and indicates that a trend reversal may occur soon. In this, the price and the oscillator always either form lower lows or equal lows. The divergence cheat sheet includes are the four types of oscillator divergence in trading.

The most significant advantage of trading divergences is that they provide you with trading signals before the price trend changes, giving you ample time to alter trades if needed. Let’s take a look at everything you need to know to trade bullish and bearish divergences. Proponents of technical analysis often emphasise the importance of chart patterns, moving averages, and oscillators.

Conversely, on a shorter timeframe like the 15-minute chart, one can spot more RSI divergences. However, due to a lot of market noise, the accuracy of the RSI divergence will diminish. In the above section, we learnt that the RSI indicator typically moves in tandem with the price of the security. However, there are instances when the RSI indicator is moving in the opposite direction of the price of the security. If you still feel confused and don’t know how to spot a bullish divergence in the crypto movement, here are several factors you should know first.