What is Divergence? Definition of Divergence in forex

Divergence is a critical concept in Forex trading, referring to the relationship between the price of a currency pair and the indicator used to analyze it. Divergence can provide traders with valuable insights into potential trend reversals or continuation signals.

In this article, Forex89 will define divergence in Forex, explain its types, and discuss how traders use divergence to make more informed trading decisions.

Understanding Divergence in Forex Trading

In the world of Forex trading, divergence occurs when the price of a currency pair moves in one direction while an indicator, such as the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD), moves in the opposite direction. This creates a “divergence” between the two, signaling a potential shift in the market trend. Divergence can indicate either a reversal or the continuation of a current trend, depending on the context.

Now that we have a basic understanding of divergence, let’s look at the different types commonly encountered in forex trading on platforms like HFM, Forex.com, and Pepperstone.

Types of Divergence in Forex

There are two primary types of divergence that Forex traders look for: regular divergence and hidden divergence. Both types can provide different signals for traders to consider when making decisions.

Regular Divergence

Regular divergence occurs when the price forms higher highs or lower lows, but the indicator shows the opposite, such as forming lower highs or higher lows. This type of divergence typically signals a potential reversal in the current trend. For example, if the price makes a new high, but the RSI or MACD does not confirm this with a higher high, it could indicate that the bullish trend is weakening and may reverse.

Hidden Divergence

On the other hand, hidden divergence occurs when the price makes a higher low or lower high, but the indicator shows the opposite. Hidden divergence typically suggests that the current trend is likely to continue. For instance, if the price creates a higher low, but the RSI forms a lower low, it may indicate that the uptrend is still intact and that the price will likely continue its upward movement.

With an understanding of the types of divergence, we’ll now guide you through how to effectively spot these patterns in the forex market.

How to Spot Divergence in Forex

Spotting divergence in Forex is crucial for traders looking to predict potential market shifts. To do so, traders often use technical indicators like the RSI, MACD, or Stochastic Oscillator. Here’s how you can identify divergence:

• Identify the trend: Look for the direction of the market trend. Is the currency pair moving up or down?
• Analyze the indicator: Observe the behavior of an indicator such as the RSI or MACD.
• Look for price and indicator discrepancies: Compare the direction of the price movement with the direction of the indicator. If they move in opposite directions, you have found divergence.

Example of Divergence:

Let’s say you are looking at a currency pair that is trending upwards, but the RSI is showing decreasing momentum by forming lower highs. This regular bearish divergence could signal that the bullish trend is losing strength and a reversal might be imminent. On the other hand, if the price makes a higher low and the indicator shows a lower low, you might identify hidden bullish divergence, suggesting that the uptrend will likely continue.

Finally, we will explore how traders use divergence to inform their trading decisions and gain a competitive edge in the forex market.

How Traders Use Divergence to Make Decisions

Traders use divergence to anticipate potential market changes. Divergence signals are commonly used in conjunction with other technical analysis tools to confirm trading decisions. While divergence can provide valuable insights into market sentiment and possible reversals, it’s essential to wait for additional confirmation before acting on a trade.

Divergence in Trend Reversals

One of the primary ways traders use divergence is to identify potential trend reversals. For example, when regular divergence occurs during an established trend, it may suggest that the trend is weakening and a reversal is likely. This can be particularly useful when trading major currency pairs, as traders can use divergence to anticipate when the trend will change and adjust their positions accordingly.

Divergence in Trend Continuation

While divergence is often seen as a signal of reversal, hidden divergence is a powerful tool for recognizing potential trend continuations. When hidden divergence occurs, it indicates that the prevailing trend is likely to continue despite short-term retracements or pullbacks. Traders can use hidden divergence as a confirmation signal for entering trades that align with the existing trend.

Divergence is a valuable concept in Forex trading, providing traders with insights into potential trend reversals or continuations. By understanding the different types of divergence—regular and hidden—traders can enhance their ability to make informed decisions. Recognizing divergence requires skill and attention to detail, as it relies on identifying discrepancies between price action and technical indicators like the RSI or MACD. With the right tools and knowledge, divergence can help traders spot lucrative opportunities and avoid potential pitfalls in the market.