Bearish Divergence: How to Spot Market Reversals

Regular or hidden divergences can be helpful for traders to predict a possible trend change. Traders can look for a bullish or bearish divergence during an especially strong trend to watch for warning signs the trend might soon end. Both types of divergences are only confirmed in hindsight, so traders should consider other signals, patterns, and technical tools for confirmation. A divergence is often seen as a sign that the current market action is losing its momentum and weakening, meaning it could soon change direction. When a divergence is spotted, there is a significant chance of a price retracement.

Although, as with the other indicators, it is important to note that the RSI signals are not 100% reliable, so it should be used as just one part of a technical strategy. Some of the most successful forex traders will tell you that a forex divergence trading strategy is one of the most accurate strategies you can use. For technical traders, they will usually read divergence patterns as a reference, because every pattern that occurs signaled a changing trend in the market. Diverges can be considered quite reliable because they are signals used by several technical traders.

However, one of the most common problems with divergences is ‘false positives’, which is when the divergence occurs but there is no reversal. A divergence signals that the market is losing momentum but doesn’t necessarily signal a complete trend shift. This makes it important is infinox regulated for traders to have a risk management strategy in place to balance the danger of incorrect signals. Divergences are fairly simple to identify and although they are not very common, they represent very important technical signals that the market or stock trend could change.

Deepen your knowledge of technical analysis indicators and hone your skills as a trader. In bullish divergence, a negative trend is ready to reverse direction. The asset value condition shows a new low, while the indicator has yet to reach a new low. It takes a long time to see change in patterns, thus, divergence cannot be used for day trading. This term is divided into two, namely bullish and bearish divergence. However, none of this means that traders should use a single indicator to spot divergence.

• When momentum or RoC falls to a new low, the pessimism of the market is increasing, and lower prices are likely coming.
• When a divergence is spotted, there is a significant chance of a price retracement.
• Usage of MACD as a forecasting tool is quite basic, yet extremely effective.
• Several are listed with sample charts in Brainy’seBook Article TA-5210 “Divergence”.
• Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.

Basically, a divergence is an asset price trend that disagrees with the actual price movement, which is often seen as a warning to traders about the assets they own. Let’s assume that after finding strong bearish divergence with RSI, a trader decided to confirm it using MACD and Stochastic indicators. The below case study is a perfect example of a high probability bearish divergence setup.

Hidden bearish and bullish divergences are useful technical signals that tell traders who rely on them whether a market is about to resume the main trend. Divergences are usually reliable signs that the price of an asset may be reversing. The divergence between the technical indicator and the price movement can signal changes in a trend and the probabilities of a reversal. Technical oscillators used in identifying a divergence include the popular Relative Strength Index and Moving Average Convergence-Divergence . The RSI not only measures the extremes of overbought or oversold but can also show divergences between it making lower lows while price is making higher highs. The MACD can not only signal bullish or bearish crosses but also its divergence with price action shows a lack of momentum in a move.

Bearish Divergence – Introduction

Class A bearish divergences occur when prices rise to a new high but the oscillator can only muster a high that is lower than exhibited on a previous rally. Class A bearish divergences often signal a sharp and significant reversal toward a downtrend. Class A bullish divergences occur when prices reach a new low but an oscillator reaches a higher bottom than it reached during its previous decline. Class A bullish divergences are often the best signals of an impending sharp rally. A bearish divergence is defined on a chart when prices make new higher highs but a technical indicator that is an oscillator doesn’t make a new high at the same time.

This indicates that even at an increased momentum, there is enough selling going on to push the price down. This type of divergence occurs with less frequency as compared to the other types. Strong average daily range of currency pairs, which is also known as regular/classic bearish divergence, occurs when the price reaches a higher high but the oscillator makes a lower high. It means that the average momentum is decreasing even when the price is moving higher.

We prefer to lean on the daily timeframe to identify trend and key levels, while utilizing the 4H chart to locate entries. Divergence is caused by the opposite behavior of prices and technical indicators. These are helpful because they usually manage to spot price developments shortly before the price chart itself. To detect divergences, traders use technical indicators like RSI, MACD, and Stochastic – that is, the main oscillators. They’re technical indicators, and technical analysis is not a science – otherwise, everyone could become the perfect trader and earn billions in crypto trading.

Step 3 – Placing a stop loss above the closing price of the highest peak can protect the trader against significant loss if the trade doesn’t go as planned and the market keeps moving higher. Bearish divergences signify potential downtrends when prices rally to a new high while the oscillator refuses to reach a new peak. In this situation, bulls are losing their grip on the market, prices are rising only as a result of inertia, and the bears are ready to take control again. The risks of loss from investing in CFDs can be substantial and the value of your investments may fluctuate.

When the RSI line rises above 70 or dips below 30, the market is indicated as overbought or oversold respectively. In the chart below, the price of GBP/JPY makes a higher high, while the Stochastic Oscillator makes a higher low in the same period. This formation suggests the price is losing upward momentum and foreshadows a bearish reversal. As you would expect, bullish divergence is just the opposite of bearish divergence. One thing to notice about this example is that there are 2 divergence signals here.

What if you aren’t using the RSI?

In a sense, the pattern that occurs is not always the same as in theory. However, divergence is often a sign that traders should delay making decisions. It is possible that the emerging pattern will continue for a longer period of time. In the chart above, MACD lines also experience divergence with the price at that moment, forming lower highs and indicating a potential price reversal. In the chart above, the oscillator reached consecutive divergence, or double top, two times in a row.

Actually, the difference between hidden divergences and classic divergences is very subtle, and when it comes to hidden divergences, the position where you find them is what matters most. As the word suggests, divergences occur when the behavior of a price is opposite to what we expect from the observation of a technical indicator. Divergence is one of the common uses of many technical indicators, primarily the oscillators.

A hidden divergence occurs when an indicator makes a higher high or a lower low while the price action does not. This often indicates that there is still strength in the prevailing trend, and that the trend will continue. A hidden divergence is used in a similar way to a confirmation pattern.

Confirmation is when the indicator and price, or multiple indicators, are telling the trader the same thing. Ideally, traders want confirmation to enter trades and while in trades. If the price is moving up, they want their indicators to signal that the price move is likely to continue.

Advantages of Trading with Divergence — Bearish Divergence

Trading divergences are possible using the built-in technical analysis tools offered by Margex. Take a look at the four simple steps to trading bullish and bearish divergences. In the above crypto chart example, using the stochastic oscillator on ETH price charts, a more than 1,500% price increase in Ethereum followed the bullish hidden divergence. A hidden divergence signals possible continuation to the previous trend and typically takes place at the end of a consolidation phase before resuming movement in the primary trend direction. Traders can use divergences as a leading indicator, as it precedes the price action.

A regular divergence – also called a classic divergence – signals a possible end to a downtrend or an uptrend and is a reversal setup. The following guide will explain how to properly identify a bullish and bearish divergence in the price of an asset, and what the signals mean. The stochastic oscillator compares the most recent closing price to previous closing prices in a given period. The instances of the divergence trades that you have been shown are overt divergence setups. Just like the overt divergence setups, hidden divergence setups can be of the bullish or bearish variety. The bullish divergence RSI setup shows two troughs in the RSI indicator window forming higher lows while the price shows lower lows.

However, support levels may test whether or not there is enough momentum to continue downward movement. In this case, traders may analyze trading volume and other indicators to confirm the potential breakout of support levels. The RSI indicator prints a lower high, while price action has just printed a higher high. This is our signal that the momentum of the counter-trend rally has fizzled out. We can now qualify a short trade in this market as our setup requirements have been fulfilled. The bearish divergence is one of the most popular tools that traders utilize to time market reversals.

How Reliable Is Divergence?

A bullish divergence occurs when prices fall to a new low while an oscillator fails to reach a new low. This situation demonstrates that bears are losing power, and that bulls are ready to control the market again—often a bullish divergence marks the end of a downtrend. Bullish and bearish divergences occur when there is a discrepancy between a technical indicator and the market price. There are numerous tools that can be used to identify divergences – discover what they are and how to use them. You would be best placed to practice this forex divergence trading strategy on a demo account.

If a free currency strength meter occurs when the RSI is in the upper extreme range bullish investors start looking to cover their positions a little more closely. Similarly, if the bullish divergence occurs with the RSI below 30 then bearish investors or short investors will start controlling their risk and market exposure more closely. Hidden divergences exhibit similar patterns as regular divergences, but the lower highs or higher lows occur in the price chart instead of the indicator. Class B bearish divergences are illustrated by prices making a double top, with an oscillator tracing a lower second top. Class B bullish divergences occur when prices trace a double bottom, with an oscillator tracing a higher second bottom. Oscillators are most useful and issue their most valid trading signals when their readings diverge from prices.

Another way to do it is to use the Fibonacci tool on any charting platform. The tool can be repurposed to show to the multiples of risk on any trade you’re looking for. By trailing your stop loss at each blue line, you would have been able to lock in profits as price moved in your favor.

Bearish Divergence

In either case, the signal has given you actionable information for your own portfolio management. A divergence appears when a technical indicator begins to establish a trend that disagrees with the actual price movement. For example, in the chart below you can see the QQQQ forming lower lows from January through March of 2008. Because divergences occur before the price reversals they predict, traders can use divergences as leading indicators. Divergences can clue you in that a reversal may soon occur or that a run is coming to an end. While divergences can signal an impending price reversal, they do not always.