Divergences are differences between the slopes of peaks and troughs in an indicator and the slope of peaks and troughs in price action. Divergences come in bullish and bearish varieties. They are early warnings of a change in the trend and often accompany reversal patterns.
A bullish divergence mean swing lows (troughs) in price are falling while swing lows in the oscillator are rising. Bullish divergences show exhausted short sellers, followed by an increased chance of a bullish change in trend. A trader with a long bias should be preparing for long buy entry. The entry itself should not be taken until the bullish divergence is confirmed. The price must close above the first trough in the price action forming the divergence. Only then should you actually consider entering the trade. A completed trough which appears above the first trough in the divergence is the best signal of completion. If the first trough forms in the oversold zone of a banded oscillator, the divergence’s strength increases.
A bearish divergence means that swing highs (peaks) in price are rising while swing lows in highs in the oscillator are falling. Bearish divergences show exhausted long buyers, with an increased chance of a bullish change in the trend. A trader with a short position should be bias for a short sale entry. Entries should be avoided until the divergence is confirmed. Price needs to close below the first peak in price action forming the divergence. After that point you should consider entering the trade. A peak forming below the first peak in the divergence is a stronger signal. The strength of the divergence increases if the first peak occurs in an overbought zone of a banded oscillator.
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