What is 'Divergence'

Divergence occurs when the stock price and another key indicator move in opposite directions on a chart. Divergence can be an indication of an imminent positive or negative price move.

Breaking Down 'Divergence'

Divergence in technical analysis may signal a major positive or negative price move. Positive divergence occurs when the price of a security makes a new low while a key indicator such as money flow or volume starts to climb. Conversely, negative divergence is seen when the price makes a new high but the indicator being followed closes lower.

Traders use divergence to assess the underlying momentum of a stock price when determining the likelihood of a price reversal. For example, investors can plot oscillators such as momentum and volume on a chart along with the price of the stock. In the case of a stock with a rising price on a chart but oscillators trending downward, an investor may interpret this as a weakening sign in price movement. In this example, negative divergence will show on the chart and an investor should look for confirmation on a chart using other indicators to assist in making buy and sell decisions.

The opposite situation applies for positive divergence. In this case, the price of a stock would make new lows while the relative strength index (RSI) makes higher lows with each swing in the stock price. Investors may conclude that the lower lows of the stock price are losing their downward momentum and a trend reversal may soon follow.

Most indicators used in technical analysis provide three types of trading signals: crossing over a center line, crossing over a major signal line and divergence. Divergence is one of the most complex signals and one that can give less experienced investors false signals.

Misreading Divergence

As is true with all forms of technical analysis, investors should use a combination of indicators to confirm a trend reversal before changing strategy. Traders can easily misread divergence given that oscillators can be very difficult to detect and may send misleading signals. Oscillators and other charting tools perform best when used during times of relative price stability, such as when a stock trades within its historical support levels and recent highs. During a prolonged bull or bear market, in which larger economic forces may be disproportionately significant in driving prices, divergence may not be as reliable. Seasoned investors know to balance their focus on short-term charting trends with the underlying fundamentals of a stock and the economy before making trading decisions.

  1. Signal Line

    Signal lines are used in technical indicators, especially oscillators, ...
  2. Confirmation

    Confirmation refers to the use of an additional indicator or ...
  3. Klinger Oscillator

    The Klinger Oscillator was developed to determine the long-term ...
  4. Money Flow Index - MFI

    The Money Flow Index is a trading oscillator that incorporates ...
  5. False Signal

    In technical analysis, a false signal refers to an indication ...
  6. Ease Of Movement

    The Ease of Movement technical indicator shows the relationship ...
Related Articles
  1. Trading

    Trading Divergences in Forex

    Recent history of the major currency pairs shows evidence that divergence signals are often exceptionally useful.
  2. Trading

    Candlesticks and Oscillators for Successful Swing Trades

    Take advantage of short-term price moves by pinpointing reversals using candlesticks and oscillators.
  3. Investing

    The top technical indicators for commodity investing

    Learn how traders can use "the usual suspects" standard for trend trading when it comes to choosing indicators for commodities investing.
  4. 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.
  5. Trading

    Overbought or Oversold? Use the Relative Strength Index to Find Out

    Learn how to use the Relative Strength Index (RSI) for analysis and to generate buy and sell signals.
  6. Trading

    Best technical indicators to pair with the stochastic oscillator

    Learn how the stochastic oscillator indicator is sensitive to price, and discover technical indicators traders use to complement it such as the RSI and MACD.
  7. Trading

    Triple Screen Trading System - Part 6

    Williams %R can confirm the strength of trends and warn of reversals. Find out how to use it as the second screen in this triple-screen system.
  8. Trading

    3 Stocks With Bullish Volume Divergences

    When the On Balance Volume indicator posts a new high while a stock struggles at lower price levels, it predicts a bullish game of catchup.
  1. What are the most common momentum oscillators used in day trading?

    Take a look at some commonly used momentum oscillators that can also be used for intraday trading, such as stochastic oscillators ... Read Answer >>
  2. 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 >>
  3. What are the top technical indicators used for range-bound trading strategies?

    Learn how to identify when a market is range-bound and what some of the technical indicators are that work best for trading ... Read Answer >>
  4. What are the differences between Relative Strength Index (RSI) & Commodity Channel ...

    Read about some of the primary differences between the relative strength index (RSI) and the commodity channel index (CCI). Read Answer >>
  5. What are the main differences between Williams %R oscillator & The Relative Strength ...

    Learn about the Williams %R indicator and how this momentum oscillator differs from the relative strength index (RSI) both ... Read Answer >>
Trading Center