Divergence measures the strength of one currency at a time, providing signals about momentum to traders.

Convergence and divergence is a very powerful trading method. Because the signal divergence is not delayed, it is useful in predicting future price action.

When strong divergence or convergence signals appear, you can seize opportunities to enter the trade.

Essentially, a divergence is identified when the price makes a higher high or lower low, but an oscillating indicator produces the opposite signal.

Common oscillator indicators used to identify divergence signals are MACD, Stochastics, AO, RSI, CCI, etc. However, MACD and Awesome Oscillator (AO) are considered to be the best indicators for determining the divergence.

In this article, we use the AO indicator to identify divergences. With the AO indicator, the divergence usually occurs when the momentum returns to the zero line. If the zero lines are not yet, the divergence signal is not considered appropriate. As shown below:

How to apply signal divergence

When identifying divergence signals, traders need to pay attention to the turning points that create the top-bottom of the price.

When a divergence occurs, we can identify it as a signal of a trend slowdown, or a reversal signal.

A bullish divergence occurs when the price makes a lower low, but an oscillator creates a higher low. Usually, this signal occurs at the end of a downtrend. Price and momentum often move relative to each other. The price makes new lows, but the momentum to bottom is weaker, showing weaker momentum, suggesting a probable pullback or reversal move.

The same is true of a bearish divergence, where price makes a higher peak, but an oscillator makes a lower high. Usually, a bearish divergence occurs at the end of an uptrend, after which there may be a pullback or a reversal.

Divergence and convergence can be used to predict price direction in several ways such as:

  • When there are signs of convergence, the possibility of continuing the trend is high. The trend reversal is unlikely to happen (this signal is not reliable at a low time frame).
  • When there is a divergence, the possibility of a trend reversal will be higher.
  • When there are double divergences or 3 divergences, the possibility of the trend continuation will be unlikely. The possibility of a reversal will be stronger.

Divergence signals are useful for predicting the end of a trend. Traders can also increase the probability of divergence by trading the divergences only when they are confirmed across multiple timeframes. So there will be more confirmation between the price momentum.

How to use hidden divergences

The hidden divergence is a good indication of the continuation of the trend.

During an uptrend, a Hidden Divergence occurs when the price makes a higher low but an oscillator creates a lower low and vice versa. During a downtrend, Hidden divergence occurs when the price makes a lower peak but an oscillator creates a higher bottom.

Summary

Please note that the use of divergence signals also carries a certain level of risk. You should combine divergence with context analysis, incorporate supportive resistance or other indicators for further confirmation.

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