Educational Post

What is Divergence?

Divergence, in finance, occurs when an asset moves in the opposite direction of another market indicator, usually represented by a technical analysis indicator. Investors and traders use divergences to try to determine if a market trend is weakening, which can signal a period of consolidation or a reversal.

A simple example of an indicator that can reveal divergences is trading volume. In this case, a divergence occurs when the market price moves in the opposite direction of the trading volume. For example, if the price of an asset increases while the volume decreases, this can be interpreted as a divergence.

While divergences can exist between the market price of an asset and any other data, they are most commonly associated with technical analysis indicators, particularly oscillators such as the Relative Strength Index (RSI) or Stochastic RSI.

Divergences can be positive or negative, although they are not always present. A positive divergence can occur when the price of an asset is decreasing, but a technical indicator is showing an increase in buying strength (or a decrease in selling pressure).

A positive divergence is often seen as a bullish signal and can, in some cases, signal a reversal of the upward trend. Conversely, a negative divergence occurs when the price is increasing, but the indicator is showing a decrease in buying strength (or an increase in selling pressure).

Divergences can help traders define their entry and exit points as well as their stop-loss levels. However, it is important to note that divergences are not always visible and can also generate false trading signals; it is therefore prudent to use them in conjunction with other analyses.