Divergence is a situation when the asset price is moving in the opposite direction than a technical indicator. It is often considered a sign that the established market movement is weakening and losing its momentum. Traders use divergences as a leading indicator that may signal a potential change in price direction.
If divergence hints at the following upward movement, it is called bullish divergence. To find bullish divergence, traders should look only at the lows/bottoms of both price actions and indicators. If you want to draw a line between bottoms to spot divergence, keep in mind that you should connect the candlestick bodies, not the wicks.
Once you have connected two or more bottoms with a line, you can use a preferred indicator to see whether a price action differs from your technical analysis tool. In most cases, traders use momentum oscillators, while the relative strength index (RSI) could be the most popular choice. In turn, traders predominantly use higher time frames to uncover potential divergences.
Let’s take a look at the following examples to recognize different types of bullish divergence.
Strong Bullish Divergence
Strong bullish divergence, or regular/classic bullish divergence, appears when the price reaches a lower low but the oscillator reaches a higher low. This means that sellers are not selling at the same momentum, while the price is moving down. Such a situation may predict a potential bottom of the established downtrend.
Once spotting a divergence, traders may find a trend-reversal candlestick pattern that follows divergence. It may act as an additional confirmation for a bullish signal. In addition, traders should pay attention to resistance levels because they may test whether or not there is enough momentum to continue the upward movement. To confirm the potential breakout of resistance levels, traders may analyze trading volume and other indicators.
When trading bullish divergence, the most common entry points are when the market closes with the first green candle and after the breakout of the resistance level.
Medium Bullish Divergence
Medium bullish divergence occurs when the price makes a double bottom, but the oscillator creates a higher low.
In the chart above, the price experienced change in momentum after the divergence. After that, the price broke the lower resistance level but rebounded from the upper one, and continued the downward movement. Keep in mind that divergence indicates a potential change in momentum, but it may not lead to a trend reversal.
Weak Bullish Divergence
Weak bullish divergence is found when the price reaches a lower low but the oscillator remains at the same low levels (double bottoms). This suggests that the momentum is intact even though the price is decreasing.
As you can see in the chart above, the price didn’t experience an immediate change in momentum after divergence.
Hidden Bullish Divergence
Unlike previous types, hidden bullish divergence forms during the uptrend and indicates its potential continuation. This signifies that even at a reducing momentum, there is enough buying interest to push the price upwards.
Note that divergence may form across more than two highs, meaning divergence may persist for a long time.
Bullish Divergence Trading Indicators
Although RSI is considered a common way to spot divergence on the price chart, there are a few technical indicators that have become popular among traders for identifying momentum and uncovering potential divergence. They include the commodity channel index (CCI), Stochastic, Williams %R, moving average convergence divergence (MACD), and on-balance volume (OBV).
If necessary, traders may not stick to a single indicator to verify whether the asset experiences divergence. They may analyze other indicators as a confirmation of potential bullish signals.
For example, let’s assume that a trader decided to analyze hidden divergence using Stochastic and MACD, after spotting it with RSI.
As you can see, Stochastic also experiences hidden divergence with the price at that moment, forming lower lows and indicating a potential continuation of the upward movement.
In the chart above, MACD lines correspond to RSI and Stochastic, showing hidden divergence. But the perspective is slightly different and not all lows across the observed time period touch the line. Therefore, traders may doubt the formation of divergence if they used only MACD for analysis.
If several indicators follow each other in terms of bullish divergence, it could potentially render the bullish signal more valid. However, indicators often follow the price when others show divergence, providing contradictory information. In these cases, traders may use other methods of market analysis to assess further price movements.
Closing thoughts
Divergence is considered a reliable indicator of potential price retracements, but it doesn’t necessarily signal a complete trend shift or immediate price reversal. Divergences may persist for a long time, and they don’t provide a potential price target. Because of that, traders should apply other forms of analysis to confirm signals offered by divergence.
Disclaimer: For information purposes only. Not investment or financial advice. Seek professional advice. Digital assets involve risk. Do your own research.
