Divergence, which is a term that technicians use when two or more averages or indices fail to show confirming trends, is one of the mainstays of technical analysis. Here's a new way to use oscillators and divergence as well as methods to locate entry levels during a trend. By Barbara Star, Ph.D.
Most technical indicators mirror or confirm price movement. When price moves up, the
indicator moves up; when price moves down, the indicator moves down. When prices peak, the
indicator peaks; and when prices bottom, the indicator bottoms. Sometimes, however, a
discrepancy occurs between price and indicator movement. That discrepancy is known as
nonconfirmation and can be seen most clearly on overbought or oversold indicators as well as
on indicators that move above or below a zero line.
Many traders only learn to recognize the type of nonconfirmation that occurs at market tops and
bottoms, which is the classic divergence. But there are other forms of nonconfirmation I call
hidden divergence (HD) that, when present, offer additional profit potential.
Hidden divergences are the opposite of classic divergences. Classic divergence looks for lower
low prices accompanied by higher indicator values at price bottoms and higher high prices
accompanied by lower indicator values at price tops. Hidden divergences, on the other hand,
seek higher price lows accompanied by lower indicator values during up moves and lower price
highs accompanied by higher indicator values during down moves. Most hidden divergences
signal continuation moves in the direction of the prevailing trend.