Before proceeding directly to the description, it should be said that this is one of the most powerful tools of technical analysis. Indeed, divergence often gives indicative signals for opening a position and can be used in trading systems to improve efficiency and reliability. As such, forex divergence can be applied at any time intervals and currency pairs. And it consists in the divergence of the direction of price movement and one of the oscillators, which can be used as:
– MACD; – RSI; – Stochastic.
As you know, even with the strongest trends, the direction of movement of the indicator coincides with the direction of price movement. But sometimes there is a discrepancy: when the graph continues to draw a higher or, conversely, a lower peak, the oscillator does not draw the same peak, but demonstrates a reverse directional movement. This discrepancy is considered a divergence and is regarded as an indicator of a sharp weakening of the trend and a possible change in the direction of its movement.
What could be the divergence?
At the same time, it should be said about the existence of several types of divergences:
Often, traders use exactly the classic type of this indicator, in which there is a decrease in oscillator performance with an increasing trend or vice versa, which is a sign of a change in the price movement direction.
If we talk about the hidden divergence, it, on the contrary, indicates the continuation of the existing direction of motion. Hidden divergence is estimated by the trend correction and is observed in cases where the next correction on the price chart is less pronounced, but the oscillator shows a greater failure or growth than the previous one.
But extended divergence is also often an indicator of continued movement and is observed in cases where the price chart draws a double bottom (with an upward trend – a double top), while the second peak on the oscillator is higher or lower than the previous one.
Thus, the detection of divergence and its correct interpretation can be used as a reliable factor that determines the likely direction of price movement in the future, and allows you to make a decision about opening a buy or sell position.