Before reading through this lesson, you should have previously read through:

The video player is loading...

Divergence is a concept that can allow a trader to see a possible reversal in the direction of price ahead of time.

What is divergence? Divergence is used to spot a reversal in the direction of price ahead of time. It shows that conditions could be changing and allows a trader to look for possible entries in the opposite direction of the trend.

When you see a divergence, it is not a definite indication that the market will change, or that as soon as a divergence is seen, a trader should enter a counter-trend trade. It does, however, allow a trader to see that the current market conditions could be changing and they should start looking for possible entries in the opposite direction to the current trend. The higher the time frame the stronger the likelihood that a reversal may occur.

What is divergence and how to spot it

Usually when using indicators, you would look for specific signals — for example, when the stochastic indicator crosses the 20 or 80 line, or for the MACD lines to cross over.

Generally, an indicator will move in conjunction with the price — if the price is making higher highs, then the indicator will also make higher highs, as observed by the chart below.

No divergence stochastic

number_1 Higher highs on the price and higher highs on the indicator

However, a divergence takes place when the indicator moves out of sync with the price action over a period of time. The length of the time is unimportant, just enough to make the comparison.

To find a divergence, first see which way the market is trading. In the chart below, price is making a series of lower lows and lower highs denoting a downtrend. The indicator, however, is not making lower lows; it has made a higher low.

Divergence MACD

number_1 Lower lows on the price chart
number_2 Higher lows on indicator chart
number_3 Soon after the divergence has taken place, price enters into a new direction

Key points to remember:

  • The higher the time frame, the longer it may take for the trend reversal to actually happen.
  • Divergence can be used on a lower time frame, but it pays to be a little more cautious. Sometimes by the time you spot a divergence on a lower time frame, the reversal may have already happened.

As you can see in the chart, a divergence has taken place between the price action and the indicator. The price has made lower lows, but the MACD histogram has made higher lows. Soon after, the downtrend starts to reverse to the upside.

It takes practice to spot a divergence. However, once you are accustomed to finding them, they can be a useful tool to spot upcoming trend changes.

Which indicators can be used to find divergence?

Common indicators are the stochastic indicator, the MACD and the OsMA. However, almost all indicators can be used to find divergence.

The chart below shows an example of divergence being spotted using the stochastic indicator.

Divergence stochastic

number_1 Price shows higher highs
number_2 Stochastic shows lower highs
number_3 Price direction reverses

The chart below shows an example of divergence being spotted using the OsMA indicator.

Divergence OsMA

number_1 Price shows higher highs
number_2 OsMA shows lower highs
number_3 Price direction reverses

Looking for a mentor?

Matthias from our Tradimo Premium team will design a learning plan tailored to you that gives you access to new courses and live webinars every month as well as priority private email support.

Order our Tradimo Premium Service now

Using divergence for trading

A bearish divergence is shown by a higher high on the price chart, a lower high on the indicator, and is typically used to look for short trades. A bullish divergence is shown by a lower low on the price chart, higher low on the indicator, and is typically used to find long trades.

There are a number of ways you can use divergence for trading. However, you should remember that divergence is a concept that should be used in conjunction with a strategy. That means you still need to define your entry point, your stop loss and your profit target. Divergence can be helpful in preparing you to get into a new trend direction early on.

The following table gives you an overview of what kind of divergence is taking place, the behaviour of the price action and indicator, and what kind of a trade you should look for.

Type of DivergencePrice ActionIndicatorType of Trade to Look for
Bearish DivergenceHigher HighLower HighShort trade
Bullish DivergenceLower LowHigher LowLong trade

Below are a few examples of how you can apply divergence in your trading decisions.

Trend line break out

Using a trend line as shown in the chart below, you can find an entry by first finding a divergence and then entering into a position once the price action breaks the trend line. This can be used in conjunction with multiple time frame analysis or on a single time frame.

Divergence trend line breakout

number_1 Price action shows lower lows
number_2 MACD shows higher lows
el3 Entry after the breakout through the trend line

Multiple time frame analysis

Divergence can be combined with multiple time frame analysis. If you are using a higher time frame to identify the direction, then a divergence can help you find a change in the overall trend. It is then possible to go to a lower time frame and find an entry using a specific method, such as a trend line breakout.

In the chart below, a higher time frame is used to determine the market direction; the indicator shows a divergence, thus indicating a price reversal.

Divergence 5 minute time frame

number_1 Price shows higher highs
number_2 OsMA shows lower highs
number_3 Price direction reverses

You can then move to a lower time frame to find possible entries, as shown in the chart below.

Divergence 1 minute time frame

es1 Possible entries after the trend line is broken

Summary

So far, you have learned that ...

  • ... divergence is a way of identifying a possible change in market direction ahead of time.
  • ... it can be a powerful tool to enter into a counter-trend trade.
  • ... there are two types of divergence: bearish, shown as higher highs on the price chart and lower highs on the indicator; and bullish, shown as lower lows on the price chart and higher lows on the indicator.
  • ... on a higher time frame it may take longer for the reversal to happen.
  • ... the higher the time frame, the more reliable the signal is.
  • ... to find entries, divergence can be combined with multiple time frame analysis or a trend line break.

Looking for a Top Broker? Sign up through Tradimo & get extra benefits!

eToro Plus500 Markets.com FXFlat

See all top brokers


  • Hello,
    When using the MACD indicator for finding divergence, we use the MACD line or the histogram?
    Thank you.
  • Hi Brettwilde,
    i saw people mostly use the MACD lines, but they kind of go hand-in-hand as the Histogram is nothing but: distance between the MACD line and the signal line and so this shows when the signal line and the MACD lines are converging or diverging, thus expressing growing or slowing momentum and divergence trading is about tracking discrepancy between price and momentum. Let me know if you have more questions.
    Regards.
    Peter
  • Hi Peter,

    Phewww... divergence and h. divergence tough concepts.
    too many doubts when applying these concepts..
    1) which line is MACD ? black, faster moving, #2
    2) use Tradimo MACD or default MACD ? Tradimo ! but i feel MACD-2 histograms have noise.
    3) use histogram, MACD or Signal Line ? MACD !
    4) which time frame for Intra-day trader ? please suggest.

    Ever since i have read these 2 concepts.. I am always looking for divergence / h. divergence and i fail to notice/realise that many a times the price and the indicator (MACD, in my case) are just moving in Sync. And i was just trying to read too much into it ! any suggestions on when to look for divergence ?

    Cheers,
  • Hi iPM25,
    I would suggest you start with just one concept, the standard divergence. The hidden divergence is less common and far less traders monitor it.

    To gain a better understanding of the MACD check out the relevant article. In the above example both the MACD and the signal lines are black, because the emphasis is on the divergence, not the MACD signals. The faster moving line is the MACD, slower one the signal line. You can use both MACD types but the one we show here in our lesson is more commonly used. For divergence traders normally just use the MACD hills/valleys, but again some prefer the histogram. Regarding the question about intraday trading I think it should be asked the other way around. First find a time frame you are comfortable with and can manage and then it will turn out whether you are an intraday or a swing trader!

    Try to keep it simple and just focus on 1-2 aspects of the indicator, don't try to use it in each and every possible way it can be used. If you want to trade divergence, decide if you watch the histogram or the line and stick to it! Then ignore crossovers, negative/positive histogram readings, colors etc...

    Hope that helps.
    Regards.
    Peter
  • Hey Peter,
    thank you for asking the absolutely right questions. smile

Register Now - It's free!

By clicking on the "Get instant access" button, you agree that you have read, understood, and accepted the Terms & Conditions.
Or