Tuesday, June 22, 2021

Trading with Divergence – The Right Way

Video Language: Hindi

[DIVERGENCE] When an underlying or a scrip trades in a trendy market it is difficult to find out or we can say that it is difficult to anticipate the end of the trend.

Anticipating any end of the trade can have many reasons like if u holding a position & you want to know up to which level you should hold that particular position, specially when you are having a mind setup of a trader.

You might have encountered a situation when you were having questions in your mind that up to which level I should hold my position? Where will this trend is going to halt? From which level the reversal of the trend will happen?

These all queries can be solved somewhat with the help of identifying the divergence on the momentum indicators on that particular time frame that you are trading.

When I talk about the momentum indicators, they can be of any type viz. leading indicators like RSI, Stochastic or some lagging indicators like MACD, Bollinger bands & many more.

What is Divergence?

When the price of an asset is behaving opposite of the technical indicator such as momentum indicator or an oscillator, it is said to be an existence of some Divergence on the charts of that particular asset.

Divergence gives a signal that the current trend of the underlying may be weakening, or the trend is going to end here & it is likely to get a reversal on the charts.

There are two types of Divergence on the charts:

1. Positive Divergence OR Bullish Divergence
2. Negative Divergence OR Bearish Divergence

Bullish Divergence

It indicates a possible move on the upside

It occurs when the price makes lower bottoms on the charts, while the indicator makes higher bottoms on the chart.

This indicates that the price is just about to a move on upside direction in that particular time frame in which you have identified the divergence.

Bullish Divergence
Bullish Divergence or Positive Divergence

Explanation:

The above image is the weekly candlestick chart of Crude Oil (WTI). As per the image after a big fall in the crude prices they have made a low around 43.75 $ on 26 Jan 2015 weekly candle & so the RSI also made a low.

After a few weeks, the crude prices broke the previous low & made a new low around 38$ which can be seen on the weekly candle of 17 Aug 2015.

But when we see to the RSI, it has not broken its previous low which was formed on 26 Jan 2015 weekly chart.

Similarly, after a few weeks, the crude prices broke the previous low & made a new low around 25$ which can be seen on the weekly candle of 8 Feb 2016.

But again when we see the RSI, it has not broken its previous low which was formed on 17 Aug 2015.

This means Prices were creating lower lows but the RSI was creating higher lows.

As per the definition, there was an existence of a Bullish Divergence on the chart. The consequence of this was to be expected as a big upside rally on the weekly time frame.

And, we can see that we had a movement from 26$ to 76$.

Bearish Divergence

It indicates a possible move on the downside

It occurs when the price makes higher tops on the charts, while the indicator makes lower tops on the chart. This indicates that the price is just about to give a move on the downward direction in that particular time frame in which you have identified the divergence.

Bearish Divergence
Bearish Divergence or Negative Divergence

Explanation:

The above image is the weekly candlestick chart of Crude Oil (WTI).

As per the image after as big rally upside in the crude prices, they have made a top around 66$ on 22 Jan 2018 weekly candle & so the RSI also made a top.

After a few weeks, the crude prices broke the previous top & made a new top around 71$ which can be seen on the weekly candle of 14 May 2018.

But when we see the RSI, it has not broken its previous top which was formed on 22 Jan 2018 weekly candle.

After a few weeks, the crude prices broke the previous top & made a new top around 75$ which can be seen on the weekly candle of 2nd Jul 2018.

But again when we see to the RSI, it has not broken its previous top which was formed on 14 May 2018.

Again after a few weeks, the crude prices broke the previous top & made a new top around 76$ which can be seen on the weekly candle of 8th Oct 2018.

But again when we see to the RSI, it has not broken its previous top which was formed on 2nd Jul 2018.

This means Prices were creating higher highs but the RSI was creating lower highs.

As per the definition, there was an existence of a Bearish Divergence on the chart. The consequence of this was to be expected as a big downside movement on the weekly time frame.

And, we can see that we had a movement from 76$ to 42$.

I hope that you learned something new today. Do you have any questions? Do comment and I’ll try to answer.

POST AUTHOR

Manish Bhardwaj
Manish Bhardwaj is a full-time trader investor, an analyst for over six years and now, he is also a trading content creator. On a random day, Manish and Sharat were discussing their plans of helping people and both understood that they have almost the same vision. So, they collaborated to take TradingSutra to the next level.

8 COMMENTS

    • Your target should be the immediate support or resistance on the time frame which you are trading & identified that divergence. Moreover your indicator will give you another divergence on that time frame as an exit signal !

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