Divergences

You can spot a bearish or bullish divergence between price and a momentum indicator and explain why it is a warning, not a timing signal.

Price up, momentum down

The price makes a new high. On the chart, the uptrend looks perfectly healthy: higher highs, higher lows. But under the chart, the momentum indicator has turned lower and refuses to follow.

That disagreement is called a divergence. It is one of the most popular ideas in technical analysis, and also one of the most frequently misused, because it says something real about strength and very little about timing.

Higher high, weaker push

A divergence is a disagreement between the price and a momentum indicator such as the RSI or the MACD:

Bearish divergence: the price makes a higher high, but the indicator makes a lower high. The second push higher had less force behind it than the first.
Bullish divergence: the price makes a lower low, but the indicator makes a higher low. Sellers pushed the price lower, but with less force.

Why does this happen? Momentum indicators compare the size of recent moves. If the second rally is slower or more hesitant than the first, the price can still reach a new high while the indicator falls short. It is the same idea as the rising wedge from the patterns chapter, expressed in numbers.

In the fictional chart, the price rises from 60 to a first high at 70.51 on candle 24. The RSI reaches about 90 there. After a pullback, the price rallies again to a slightly higher high at 71.29 on candle 37. This time, the RSI only reaches about 77. The price made a higher high; the RSI made a lower high.

The limits are important. A divergence shows that momentum is fading, but trends can keep going on fading momentum for a long time. Divergences can repeat over three or four new highs before any turn, and many never lead to one. That is why many traders treat a divergence as a warning and wait for the price structure itself to change, for example a break of the last higher low, as in the lesson on trend changes.

This time, a turn

Follow the fictional chart after the second high.

Candle 37 reaches 71.29 and closes at 69.89, below its open.
The next candles make lower highs. By candle 41, the price has fallen below the pullback low around 67.
By candle 50, the price is at 63.50, after a decline of more than 7 points from the high.

Here, the divergence came right before the turn. That is the version shown in most examples, and it is why divergences look so useful in hindsight. On a real chart, the same divergence would often have been followed by another new high and another lower RSI peak, and a trader acting on the first divergence would have been stopped out.

Common mistakes

Selling on the first divergence. Many trends continue for a long time.
Comparing the wrong points. Compare indicator values at the same swing highs or lows as the price.
Ignoring the timeframe. Divergences on tiny timeframes are common and mean little.
Seeing only the examples that worked. Divergences that failed rarely appear in tutorials.

The takeaway

A divergence is when price makes a new high or low but momentum doesn't. It warns that a move is losing strength, often long before any turn.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the higher price high that the RSI did not confirm.

Tap the chart.

Candle 37 made a higher high at 71.29, but the RSI peaked near 77, well below the roughly 90 it reached at the first high.
2What is a bearish divergence?

The second push higher had less momentum than the first. That mismatch is the divergence.
3What does a bullish divergence look like?

Sellers pushed the price lower, but with less force than before.
4Why is a divergence a poor timing signal on its own?

Momentum can fade for a long time while the trend continues. Many traders wait for the price structure to confirm.

of 4 correct.

Sources

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