Divergence can be seen when an indicator and the price of an asset are heading in opposite directions.
Negative divergence happens when the price of a security is in an uptrend and a major indicator – such as the moving average convergence divergence, price rate of change or relative strength index – heads downward.
Positive divergence occurs when the price is in a downtrend but an indicator starts to rise. These are usually reliable signs that the price of an asset may be reversing.
When using divergence to help make trading decisions, be aware that indicator divergence can occur over extended periods of time, so tools such as trendlines, support and resistance levels should also be used to help confirm the reversal.
When used efficiently, you can be consistently profitable with divergences. The best thing about divergences is that you’re usually buying near the bottom or selling near the top. This makes the risk on your trades are very small relative to your potential reward.
There are TWO types of divergence:
If price is making lower lows (LL), but the oscillator is making higher lows (HL), this is considered to be regular bullish divergence.
Hidden bullish divergence happens when price is making a higher low (HL), but the oscillator is showing a lower low (LL).
Divergence should be considered to be an indicator, not a signal to enter a trade. It would be unwise to enter a trade basely solely on this indicator as too many false signals are given; however, on the other hand, it may be considered even more unwise to trade against this indicator.