Forex Trading: Divergence Explained

Divergence in forex trading happens when the price of the traded currency pair is moving in the opposite direction of a technical indicator, usually an oscillator.

Divergence can be bullish or bearish. Bullish divergence indicates that the price is about to move higher. While the bearish divergence indicates lower prices.

Learn more about Bullish and Bearish market trends.

Forex Divergence Explained

Divergence is a powerful signal in technical analysis that points out positive or negative price moves ahead. Positive divergence occurs when the price makes a new low, while the indicator moves higher. On the other hand, negative divergence is when the price form new highs while the indicator makes a lower high.

For example, when the price of a currency pair is moving higher and forming new highs and the MACD is making lower highs, it is a warning sign that the price trend is losing momentum and most probably will reverse.

Usually, divergence is used to assess the price momentum and the odds for price reversals.

Divergence Technical Indicators

Oscillators are the best and most common indicators used to detect price divergence in forex trading. Popular oscillators used for identifying divergence are:

Moving Average Convergence and Divergence (MACD)

The MACD is a trend-following momentum indicator that assesses market forces and indicates changes in momentum, direction, and strength of a price trend. MACD is calculated by subtracting the long-term exponential moving average (EMA) from the short-term EMA. The indicator is bullish when the MACD line is heading up, and bearish when it falls lower below the zero level.

Stochastic

Stochastic is another popular momentum indicator that is created to show overbought and oversold zones. It is commonly used to identify possible profit-taking levels due to its ability to pinpoint where the price is expected to reverse. Also, it can measure price momentum by comparing trading range and closing price over a certain period. The Stochastic ranges from 0 to 100 levels. Below 20 represents an oversold market, and above 80 reflects an oversold market.

Relative Strength Indicator (RSI)

The RSI is one of the most common technical indicators. It is used to identify overbought and oversold conditions, price momentum, and reversals. The relative strength indicator is shown as levels from 0 to 100. The RSI signals an overbought market by breaching 70, while lower than 30 indicates an oversold market.

Bottom Line

Divergence is when the price is moving in the opposite direction of a technical indicator like RSI, oscillator, or MACD. It is a very powerful signal in forex technical analysis and can efficiently signal a price reversal.

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