Divergence occurs when the movement of a momentum oscillator does not agree with the price movement. Divergence gives signs of the hidden strengths and weaknesses of a price trend. Prices may rise and fall, but if the momentum oscillator fails to confirm the corresponding price trend, the resulting discrepancy is an advance warning of a probable change in the price trend in the very near term.
There are four patterns of divergences. They are the two classic divergences, comprising bullish divergence and bearish divergence; and the two hidden divergences, comprising hidden bullish divergence and hidden bearish divergence.
Bullish divergence occurs when the price is declining while the momentum oscillator is rising. This pattern can be seen generally at a market low. Bullish divergence occurs when the market is reaching a support level and is preparing for an eventual rally. In the beginning of a bullish buildup, the price fails to show any signs of rallying as weak investors are selling to strong investors. As more investors enter the market and when the accumulation process is over, the price will rally.
The other classic divergence is bearish divergence. Bearish divergence is the opposite of bullish divergence. It occurs when the price is rising while the momentum is declining. The pattern looks for higher high prices and lower low oscillator values. Bearish divergence happens when the market is preparing for a corrective decline. In the beginning of the bearish ...