Divergence is when price and a momentum indicator such as RSI or MACD disagree about a swing. Regular divergence warns that a trend is tiring, and hidden divergence suggests a pullback inside a trend is ending. Neither one is an entry by itself, so you will also learn what to wait for before you act.
What you will learn
- How to line up two swings on price with the same two swings on RSI or MACD
- The four kinds: regular and hidden, each bullish or bearish
- Why divergence needs a trigger from price before it means anything
- How to turn one divergence into a trade plan with a stop and a target
Line up the swings first
Divergence compares two swing points on price with the indicator readings at those same candles. Most misreads come from comparing the wrong candles.
- Pick two clear swing highs, or two clear swing lows, that belong to the same move.
- Drop a vertical line from each swing down to the indicator panel.
- Read RSI or MACD where those lines cross it. Ignore the indicator's own peak if it sits on a different candle.
- Compare the direction of the two price points with the direction of the two indicator points.
With MACD, choose either the histogram or the MACD line and stay with it, because they can disagree with each other. Keep the default settings from the indicators lesson (RSI 14, MACD 12, 26 and 9). If you change the settings until a divergence appears, the signal comes from your tuning and not from the market.
Regular divergence warns that a trend is tiring
Regular bearish divergence is a higher high on price with a lower high on the indicator. Buyers pushed price to a new high, but with less force than the last time.
Regular bullish divergence is a lower low on price with a higher low on the indicator. Sellers made a new low, but the drop that got there was weaker.
Treat regular divergence as a warning. In a strong trend you will often see two or three in a row while price keeps going, so a trader who sells the first bearish divergence in a strong uptrend can lose three times before the turn arrives. Use it to stop adding trades in the trend's direction, to tighten your plan on an open trade, or to start watching for a break of structure. Only that break makes it a reversal setup.
Hidden divergence suggests a pullback is ending
Hidden bullish divergence is a higher low on price with a lower low on the indicator. Inside an uptrend, the pullback knocked momentum down further than it knocked price, which often comes near the end of the pullback.
Hidden bearish divergence is a lower high on price with a higher high on the indicator. Inside a downtrend, a rally pushed momentum up but stalled below the last high on price.
Hidden divergence trades with the trend, so it depends on the trend read from trends and trendlines. A hidden bullish divergence inside a downtrend tells you little.
To keep them apart, look at which swings you are comparing. Regular divergence compares the extremes (higher highs, lower lows) and points to a possible reversal. Hidden divergence compares the pullbacks (higher lows, lower highs) and points to continuation.
Turn a divergence into a plan
Here is a regular bullish divergence on the EUR/USD 4-hour chart, worked through to a full plan.
- Price falls to 1.0820 with RSI at 24, bounces to 1.0870, then falls again to a new low at 1.0795.
- RSI at the second low reads 31. Price made a lower low, 25 pips under the first, while RSI made a higher low. That is regular bullish divergence.
- You do not buy yet. The trigger is a 4-hour close above 1.0870, the high between the two lows, because that breaks the run of lower highs.
- A candle closes at 1.0875. You enter there, with a stop 15 pips under the low at 1.0780. That is 95 pips of risk.
- The fall began at 1.1065, an obvious resistance level. From 1.0875 that is 190 pips, twice the risk.
- If you risk $100, that is $100 ÷ 95 pips, or about $1.05 a pip. A standard lot of EUR/USD moves $10 a pip, so 0.10 lots risks $95.
If price never closes above 1.0870 and instead breaks below 1.0795, the divergence has failed and you never had a trade to lose on. Waiting for the trigger costs you some of the move, and in return it filters out many of the divergences that fail.
The same read works on MACD. If the histogram reached minus 0.0018 at the first low and only minus 0.0009 at the second, momentum halved while price went lower.
Where divergence lets you down
In a strong trend, regular divergence can repeat many times before price turns. On very short timeframes such as the 1-minute chart, small swings throw up divergences that mean almost nothing, and around big news price can jump through a level before any indicator reacts.
It works better at a level you already trust. A regular bullish divergence that forms at a support level from lesson 2 has two reasons behind it, where one formed in the middle of a range has one.
Check your understanding
Price makes a higher low in an uptrend while RSI makes a lower low. What is this, and what does it suggest?
Hidden bullish divergence. It suggests the pullback may be ending and the uptrend may continue.
You see regular bearish divergence on the 1-hour chart in a strong uptrend. Should you sell straight away?
No. Regular divergence is a warning and often repeats in strong trends. Wait for price to break its structure, such as a close below the last higher low, before treating it as a reversal.
In the EUR/USD plan above, why is the stop at 1.0780 rather than 1.0820?
The idea behind the trade is that 1.0795 was the final low. If price trades below it, the idea is wrong, so the stop goes under that low with a buffer.
Key points
- Compare price and the indicator at the same candles, and keep the default settings.
- Regular divergence compares the new highs or new lows and warns of a possible reversal.
- Hidden divergence compares the pullbacks and points to the trend continuing.
- Wait for price to confirm, then set the stop where the idea is proved wrong.
Next lesson: Mark supply, demand and imbalance zones before price returns
All trading is simulated. Rewards are based on performance and are not guaranteed.