What is 'Divergence'

Divergence appears on a bar chart when the price of an asset and an indicator, index or other related asset move in opposite directions. In technical analysis, traders make transaction decisions by identifying situations of divergence, where the price of a stock and a set of relevant indicators, such as the money flow index (MFI), are moving in opposite directions.

BREAKING DOWN 'Divergence'

Divergence

In technical analysis, divergence is considered to be positive or negative. Either direction is a signal of a major shift in the direction of the price. Positive divergence occurs when the price of a security makes a new low while the indicator starts to climb. Negative divergence happens when the price of the security makes a new high, but the indicator fails to do the same and instead closes lower than the previous high.

[ Divergence is a great indicator of potential reversals in the future, but traders should look for confirmation in other technical indicators. If you'd like to learn about other indicators, Investopedia's Technical Analysis Course provides a comprehensive introduction to the subject. You'll learn basic and advanced technical analysis, chart reading techniques, and the indicators that you need to succeed in over five hours of on-demand video, exercises, and interactive content. ]

Interpreting Divergence

Divergence is usually associated with oscillator indicators. Oscillators measure the position of the current data for a specific factor (such as price, momentum or volume) relative to the total range of said factor for a specified number of historical bars on a bar chart. The calculation for oscillators takes various factors into account. A situation in which the calculation of an oscillator results in peaks that are trending lower, while the price action of the underlying security is exhibiting peaks that are making new highs with every price swing, indicates that each new high achieved by the underlying price is getting weaker in terms of the factor that is measured by the oscillator. On an appropriate price chart, a display of negative divergence will appear.

For example, the Chaikin oscillator, takes the trading volume of the underlying security into account. In a negative divergence situation (also referred to as bearish divergence), as price makes higher highs while the Chaikin indicator makes lower highs with each price swing, traders can conclude that the higher highs for price are being made with decreasing volume, signaling a potential reversal to the downside.

The inverse holds true for positive divergence. The relative strength index (RSI) takes into account the momentum of price action for the underlying security. In a positive divergence situation (also referred to as bullish divergence), as price makes lower lows while RSI makes higher lows with each price swing, traders can conclude that the lower lows for price are being made with less and less momentum, signaling a potential reversal to the upside.

Misinterpreting Divergence

Trading signals derived from divergence that are based on oscillator indicators can be difficult to read, and they are sometimes misleading. When the market is in a strong trend in either direction, oscillators do not function well. Any signs of divergence during a strong trend would be ambiguous at best. Divergence is best suited for confirming market moves and should be used in conjunction with other technical indicators and fundamental analysis.

RELATED TERMS
  1. Price Zone Oscillator

    The Price Zone Oscillator is a technical indicator that measures ...
  2. Oscillator

    A technical analysis tool that is banded between two extreme ...
  3. Technical Indicator

    Technical indicators are mathematical calculations based on the ...
  4. Confirmation

    Confirmation refers to the use of an additional indicator or ...
  5. Stochastic Oscillator

    A technical momentum indicator that compares a security's closing ...
  6. OsMA

    An abbreviation for Oscillator - Moving Average. OsMA is used ...
Related Articles
  1. Investing

    The top technical indicators for commodity investing

    See how traders can use "the usual suspects" standard for trend trading when it comes to choosing indicators for commodities investing.
  2. Trading

    Trend-Spotting With The Accumulation/Distribution Line

    The A/D line highlights buying and selling pressure to confirm existing trends.
  3. Trading

    Measuring Stock Market Sentiment With Extreme Indicators

    Pay attention to how the exhaustion principle helps technical indicators signal trend reversals when abrupt value changes coincide with high trading volume.
  4. Investing

    Four Breakout Stocks To Watch

    These biotechnology and pharmaceutical stocks continue to put in new highs, but indicators are diverging.
  5. Trading

    How to Use Volume to Improve Your Trading

    Volume is a simple yet powerful way for traders and investors to increase profits and minimize risks.
  6. Trading

    Percentage Price Oscillator—An 'Elegant Indicator'

    The percentage price oscillator, which measures momentum, is among the more sophisticated tools in the technical analysis arsenal.
  7. Trading

    An Introduction to Oscillators

    Find out how this indicator may help improve the average investor's entry and exit points.
  8. Trading

    How To Use The Chaikin Oscillator To Your Advantage

    How best to reconcile increasing or decreasing volume with price fluctuations? No one has a definitive answer, but Marc Chaikin has come as close as anyone. Enter the Chaikin Oscillator.
RELATED FAQS
  1. What Does it Mean to Use Technical Divergence?

    Divergence is definitely the most complicated indicator for the rookie technical trader. Read Answer >>
  2. What are the most common divergence strategies implemented in forex trading?

    Discover common divergence strategies that utilize either stochastics or the MACD, the two most frequently used momentum ... Read Answer >>
  3. What is a common strategy traders implement when using the Williams %R?

    Learn about Williams %R and how this momentum oscillator is used by investors to pinpoint potential reversals and plan for ... Read Answer >>
  4. What are the best technical indicators to complement the Stochastic Oscillator?

    Explore the function of the stochastic oscillator indicator, and discover other technical indicators traders use to complement ... Read Answer >>
  5. How do I read and interpret an Stochastic Oscillator?

    Understand the basics of the stochastic oscillator and how analysts and traders use this measure of trend momentum to predicts ... Read Answer >>
  6. How do I start using technical analysis?

    Technical analysis is a method of analyzing securities by evaluating current and historical price and/or volume activity. ... Read Answer >>
Hot Definitions
  1. Working Capital

    Working capital, also known as net working capital is a measure of a company's liquidity and operational efficiency.
  2. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  3. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  4. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  6. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
Trading Center