DIVERGENCE CHEATSHEET

2 Sep 2023

Hello dear traders and investors community!

The Divergence Cheat Sheet



Divergence occurs when the price of an asset and an indicator, such as the Relative Strength Index (RSI), move in opposite directions. This pattern provides valuable insights into potential price reversals or changes in trends.



Detecting Divergence


Detecting divergence is crucial for identifying lucrative trading opportunities. By using divergence indicators like the RSI, MACD, or Stochastic Oscillator, we can gain significant insights into market trends and potential price reversals.


To pinpoint divergence effectively, follow these steps:

Choose an indicator capable of detecting divergence, such as the RSI, MACD, or Stochastic Oscillator.

Look for discrepancies between the indicator and the price action. Regular divergence occurs when the price and the indicator move in opposite directions, while hidden divergence occurs when they move in the same direction but at different rates.

Monitor the direction of the trend. Divergence can indicate a trend reversal, so keeping track of the current market trend is crucial.

Confirm the divergence signal with other technical analysis tools. Divergence is just one piece of the puzzle, so it's essential to use other indicators to validate your trading decisions.



Examples of Divergence in Trading Charts

Let's examine a few examples of divergence on Bitcoin charts:

Strong Bullish Divergence:

When lows of the price decreases while the RSI increases, a regular bullish divergence occurs. This signals a potential trend reversal and presents an opportunity for a bullish trade.


Strong Bearish Divergence:

When highs the price of an asset is rising while the RSI is falling, it indicates a regular bearish divergence. This suggests a potential trend reversal and presents an opportunity for a bearish trade.


Medium Bullish Divergence:

When the lows of an asset remain equal while the RSI is rising, it indicates a medium bullish divergence. This suggests a potential increase in price, although it may not be a strong upward movement.


Medium Bearish Divergence:

When the highs of an asset remain unchanged while the RSI is decreasing, it indicates a medium bearish divergence. This suggests a potential decline in price, although the downward movement may not be significant.


Weak Bullish Divergence:

When the lows of an asset is decreasing while the RSI lows is equal, it indicates a weak bullish divergence. This suggests a potential increase in price, although it may not be a strong upward movement.


Weak Bearish Divergence:

When the highs of an asset are rising while the RSI remains unchanged, it indicates a moderate bearish divergence. This suggests a potential decline in price, although the downward movement may not be significant.


Hidden Bullish Divergence:

Hidden bullish divergence occurs when the price creates higher lows while the RSI is creating lower lows. This reinforces an existing uptrend and suggests its strength.


Hidden Bearish Divergence:

Hidden bearish divergence is observed when the price forms lower highs while the RSI forms higher highs. This indicates a potential weakening of the current uptrend and might signal a trend reversal or a pullback.


By recognizing these divergence patterns on trading charts, we can gain insights into potential market reversals, entry and exit points, and adjust trading strategies accordingly.



To effectively incorporate divergence into your trading, consider the following steps:

1. Identify the appropriate indicators: Choose reliable indicators such as RSI, MACD, or Stochastic Oscillator that can detect divergence patterns effectively.
   
   
2. Learn to spot divergence: Familiarize yourself with the different types of divergence patterns and practice identifying them on price charts. This will help you develop a trained eye for spotting potential trading opportunities.
   
   
3. Confirm with additional analysis: While divergence can provide valuable signals, it's essential to use other technical analysis tools to confirm your trading decisions. Look for supporting indicators, chart patterns, or trendline breaks that align with the divergence signal.
   
   
4. Set clear entry and exit criteria: Define your entry and exit points based on the divergence signal and your risk tolerance. Consider using stop-loss orders and take-profit levels to manage your trades effectively.
   
   
5. Practice risk management: Implement proper risk management techniques, such as position sizing, to protect your capital. Divergence alone should not be the sole basis for your trading decisions but rather an additional tool in your arsenal.
   
   
6. Backtest and refine your strategy: Test your divergence-based trading strategy on historical price data to assess its effectiveness. Make adjustments as needed and continuously monitor and evaluate your results to improve your trading approach.
   

Remember, divergence analysis is not foolproof and should be used in conjunction with other technical analysis methods and market factors.

Divergence analysis is a powerful tool that can provide us with an edge in the cryptocurrency market. By understanding and effectively utilizing divergence patterns, we can identify potential trend reversals, improve entry and exit timing, and enhance overall trading strategy. Incorporate divergence analysis into your trading approach and combine it with other technical indicators and risk management techniques for a well-rounded and informed trading strategy.