Divergence Definition and Uses

Divergence is when the price of an asset is moving in the opposite direction of a technical
indicator, such as an oscillator, or is moving contrary to other data. Divergence warns that the
current price trend may be weakening, and in some cases may lead to the price changing direction.
There is positive and negative divergence. Positive divergence indicates a move higher in the price
of the asset is possible. Negative divergence signals that a move lower in the asset is possible.

• Divergence can occur between the price of an asset and almost any technical or
fundamental indicator or data. Though, divergence is typically used by technical traders
when the price is moving in the opposite direction of a technical indicator.
• Positive divergence signals price could start moving higher soon. It occurs when the price is
moving lower but a technical indicator is moving higher or showing bullish signals.
• Negative divergence points to lower prices in the future. It occurs when the price is moving
higher but a technical indicator is moving lower or showing bearish signals.
• Divergence isn't to be relied on exclusively, as it doesn't provide timely trade signals.
Divergence can last a long time without a price reversal occurring.
• Divergence is not present for all major price reversals, it is only present on some.
What Does Divergence Tell You
Divergence in technical analysis may signal a major positive or negative price move. A positive
divergence occurs when the price of an asset makes a new low while an indicator, such as money
flow, starts to climb. Conversely, a negative divergence is when the price makes a new high but the
indicator being analyzed makes a lower high.
Traders use divergence to assess the underlying momentum in the price of an asset, and for
assessing the likelihood of a price reversal. For example, investors can plot oscillators, like the
Relative Strength Index (RSI), on a price chart. If the stock is rising and making new highs, ideally
the RSI is reaching new highs as well. If the stock is making new highs, but the RSI starts making
lower highs, this warns the price uptrend may be weakening. This is negative divergence. The
trader can then determine if they want to exit the position or set a stop loss in case the price starts
to decline.
Positive divergence is the opposite situation. Imagine the price of a stock is making new lows while
the RSI makes higher lows with each swing in the stock price. Investors may conclude that the
lower lows in the stock price are losing their downward momentum and a trend reversal may soon
follow.
Divergence is one of the common uses of many technical indicators, primarily the oscillators.
The Difference Between Divergence and Confirmation
Divergence is when the price and indicator are telling the trader different things. Confirmation is
when the indicator and price, or multiple indicators, are telling the trader the same thing. Ideally,
traders want confirmation to enter trades and while in trades. If the price is moving up, they want
their indicators to signal that the price move is likely to continue.
Limitations of Using Divergence
As is true with all forms of technical analysis, investors should use a combination of indicators and
analysis techniques to confirm a trend reversal before acting on divergence alone. Divergence will
not be present for all price reversals, therefore, some other form of risk control or analysis needs
to be used in conjunction with divergence.
Also, when divergence does occur, it doesn't mean the price will reverse or that a reversal will
occur soon. Divergence can last a long time, so acting on it alone could be mean substantial losses
if the price doesn't react as expected.