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Different Types of Divergences with Live Trading Examples

What is Divergence and how to trade various types of divergences in the Forex market. Trading Strategies with Divergence in Technical Analysis.

 

Hello dear readers, accurately forecasting the direction of price movements in advance is what everyone who participates in financial market trading hopes for. To achieve this, an understanding of both technical and fundamental analysis is necessary. Technical analysts participate in trading using various strategies, and one of these strategies incorporates the concept of “divergence”. When we talk about divergences in the Forex market, we refer to a situation where there is a contrast between price movement and a technical oscillator. In other words, in technical analysis, divergence indicates the disparity between a price chart and a corresponding indicator or oscillator’s movement. Such divergences are considered possible signs of a reversal in the current price trend, suggesting a likelihood that the trend might not continue. Divergences usually occur at times when price changes slow down and are seen as signs of a possible reversal. There are three types of divergences based on two main categories.


Main Categories of Divergences

Divergences in two main categories arise from the movement of lines on the price chart compared to the lines on the oscillator. These are the following divergences:

 a) Bullish Divergence or Positive Divergence. When the price chart is decreasing while an oscillator or indicator is rising, this is referred to as positive or bullish divergence. This indicates that the current downward trend might weaken and an upward reversal could be approaching. In this type of divergence, the focus is on the bottoms.

Bullish Divergence or Positive Divergence and Bearish Divergence or Negative Divergence
The Types of Divergences


 b) Bearish Divergence or Negative Divergence. When the price chart is rising while an oscillator or indicator is falling, this is known as negative or bearish divergence. It indicates that the current upward trend could weaken, suggesting a possible downward reversal. Peaks are generally considered in this type of divergence.

No matter which type of divergence it is, there are certain aspects we need to be aware of. Therefore, when plotting divergences on the chart, we should pay attention to the characteristics of the indicator we are using. For instance, the Relative Strength Index (RSI) indicator considers candle closes, so when drawing divergence lines on the price chart, we do not take the candle shadows into account.


Different Types of Divergences

As mentioned earlier, divergences signify a disparity between a price chart and an indicator or oscillator in technical analysis. These differences play a role in estimating the chances of a trend either continuing or not. There are various types of divergences, and they are as follows:

1. Regular Divergence (Standard Divergence). Regular divergence denotes the traditional disparity between a price chart and an indicator or oscillator. There are two types of standard divergence:

Bullish(or Positive) Regular Divergence: When the price drops while the indicator is ascending, it points to a prospect of a rise in the near future. Take a look at the example of the Gold/US Dollar chart.
Live trading with Bullish and Bearish Regular Divergences
Regular Divergences in the XAU/USD chart


Bearish(or Negative) Regular Divergence: When the price is increasing while the indicator is decreasing, it implies a possible signal for an upcoming decline. See example on the Spot Gold/US Dollar 4-hour chart above.

2. Hidden Divergence. Hidden divergence presents indications that a trend will continue. When a hidden divergence occurs between the price chart and an indicator or oscillator, the likelihood of the current trend persisting increases. There are two types of hidden divergence:

Bullish(Positive) Hidden Divergence: As the price forms higher low points from previous lows, if the indicator or oscillator shows lower low points, this scenario reflects the probable continuation of the existing trend. It’s a signal of a period where the price could reach higher levels. Refer to the example on the EUR/USD chart.
Live trading with Positive and Negative Hidden Divergences
Hidden Divergences in the EUR/USD chart


Bearish(Negative) Hidden Divergence: As the price creates lower high points from previous highs, if the indicator or oscillator displays higher high points, this situation reveals the weakening of the current trend. It’s a sign of a period where the price could decline in the short term. An example on the EUR/USD chart above illustrates this.

3. Exaggerated Divergence. This term is a less commonly used one that sometimes surfaces. Exaggerated divergence is a type of divergence that stands out more strongly than usual. The disparity between the price chart and the oscillator becomes so pronounced that it is considered a stronger signal of a possible trend reversal.

Bullish(Positive) Exaggerated Divergence: While the price forms the equal low points, the indicator (oscillator) shows higher low points, or conversely, the indicator forms the same low points while the price forms lower lows. See the EUR/GBP chart below.
Live trading with Bullish and Bearish Exaggerated Divergences
Exaggerated Divergences in the EUR/GBP chart


Bearish(Negative) Exaggerated Divergence: As the price creates the equal high points, the indicator (oscillator) displays lower high points, or conversely, the indicator forms the same high points while the price forms higher highs. See the EUR/GBP chart above.

Both Positive Exaggerated Divergence and Negative Exaggerated Divergence can be considered significant signs of a trend reversal. All types of divergence are used in technical analysis to aid in predicting price direction or changes in trend.

It’s important to remember. While the Forex market offers substantial opportunities, it also comes with high risks, which means there’s a possibility of losing our capital. When making trading decisions, we should carefully research, learn to manage risks, and experience different strategies. We should be aware that divergences are just one component in trading and might not always yield accurate results. When evaluating signals using tools like divergences, we must always be sensible and cautious. By combining risk management with emotional control and staying up-to-date with information, we can seize more successful trading opportunities in financial markets. Trade wisely, get good results!

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