Community Submission - Author: Caner Taçoğlu
In finance, divergence occurs when an asset’s market price is moving in the opposite direction of another piece of data, usually represented by a technical analysis indicator. Divergences are used by traders and investors in an attempt to determine if a market trend is getting weaker, which may lead to a consolidation period or a trend reversal.
Trading volume is one simple example of an indicator that can produce divergences. In this case, the market price will create a divergence when moving in a direction that goes against the trading volume. For instance, if an asset’s price is moving up with a decreasing trading volume, one could consider this to be a divergence.
Despite the fact that divergences can occur between an asset’s market price and any other piece of data, they are most commonly used in relation to technical analysis indicators, especially the oscillator types, such as the Relative Strength Index (RSI), and the Stochastic RSI.
Divergences can be positive and negative, but note that they are not always present. A positive divergence may occur when the price of an asset is decreasing, but the technical indicator suggests an increase in the buying forces (or decrease in selling). As such, a positive divergence may be considered a bullish sign and, in some cases, may precede a price reversal to the upside. In contrast, a negative divergence is seen when the price of the asset is increasing, but the indicator indicates a weakening in the buying forces (or stronger selling pressure).
Divergences may help traders determine their entry and exit points, as well as their stop losses. However, divergences should not be relied on primarily as they are not always visible and can also produce false trading signals.