Trend analysis - divergences
Divergences are among the most powerful tools in trading, but they are often misunderstood. Most traders trade with them, but when they try to automate the trading, the process becomes elusive.
A divergence can be considered an imbalance between what the price chart shows us and what an indicator shows, with the presumption that this will lead to a trend reversal. The indicator is usually an oscillator, as they are particularly suited to showing overbought or oversold conditions, but they can also be other types of indicators, such as OBV.
Let’s consider the four divergences in the following figure:
Figure 4.13 – Class A divergences
In Figure 4.13, we have the following:
- Regular bullish divergence: The price has lower lows, and the oscillator has higher lows
- Hidden bullish divergence: The price has higher lows, and the oscillator has lower lows
- Regular bearish divergence: The price has higher...
