Education - What are divergences and how do I use them?

27 Feb 2021

What are divergences and how do I use them in trading?


A divergence usually shows the trader that the price is moving in the opposite direction to the indicator (or vice versa).

To find a possible divergence in the price you can use various indicators (MACD, Stochastic, Momentum, etc.)

I will limit myself to the Momentum indicator, because I use it myself in my trading.

What does a divergence say?
As already mentioned, the indicator shows me a contrary movement to the price, related to the momentum indicator this means for example:

The price rises and forms a new high, but the momentum indicator forms a lower high in the indicator itself compared to the previous PRICE HIGH




How do I use a divergence?
A divergence can be used in many ways if you know what to do with the information gained. In my opinion, this also depends on the chosen indicator, at least in terms of the information value I get from the divergence.
If one is able to identify a divergence correctly, one receives a kind of "warning", in my opinion a divergence by itself does not represent an action signal, but it warns me that in the case of the momentum indicator it comes to a trend slowdown although the price continues to rise.





What is to be paid attention to here?
-> As mentioned, a divergence by itself is in my opinion NOT a TREND SIGNAL, but a warning or information around which I can now supplement or adjust my trading.

-> Very important, there are two ways that one "bends" the divergence to right once the setting of the indicator is crucial, since each trader uses other settings, it is important not to change these in search of a divergence so that one is formed.

->Furthermore, it is important to consider the time unit under consideration, a divergence occurring in H1 is much less meaningful than one in D1.

Summary:
Divergences are a possibility to add important information to one's trading at an early stage in order to forecast possible price changes that have not yet occurred.
They do not represent action signals on their own.