Definition of Divergence in Forex
Divergence in forex refers to a discrepancy or disagreement between the price movement of a currency pair and a related technical indicator. It occurs when the price forms higher highs or lower lows, while the corresponding indicator fails to confirm those moves by forming lower highs or higher lows. Divergence can provide traders with valuable insights into potential trend reversals or trend continuation.
There are two main types of divergence in forex trading:
Regular Divergence: Regular divergence occurs when the price forms higher highs or lower lows, but the corresponding indicator fails to follow suit. In a bullish regular divergence, the price creates a lower low, while the indicator forms a higher low. This suggests that the downward momentum is weakening, indicating a potential bullish reversal or trend continuation. In a bearish regular divergence, the price forms a higher high, while the indicator forms a lower high. This indicates potential weakening of the upward momentum and suggests a potential bearish reversal or trend continuation.
Hidden Divergence: Hidden divergence occurs when the price forms higher highs or lower lows, but the corresponding indicator fails to confirm those moves by forming lower highs or higher lows. In a bullish hidden divergence, the price creates a higher low, while the indicator forms a lower low. This suggests that the upward momentum is continuing, indicating a potential bullish trend continuation. In a bearish hidden divergence, the price forms a lower high, while the indicator forms a higher high. This indicates potential continuation of the downward momentum and suggests a potential bearish trend continuation.
Divergence can be identified using various technical indicators, such as the Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI), Stochastic Oscillator, or the Average Directional Index (ADX). Traders often combine divergence signals with other technical analysis tools, such as trend lines or support/resistance levels, to confirm the potential trading opportunities.
It's important to note that while divergence can provide valuable insights into potential trend reversals or trend continuation, it should not be used as the sole basis for trading decisions. Traders should consider other factors, such as market conditions, fundamental analysis, and risk management principles, to make well-informed trading choices.