In the world of trading, there’s a myriad of activities and factors the diligent trader must put into perspective. Amidst this flurry of things, everything boils down to two fundamental forces — the bulls and the bears. As a recap, the market is bullish when the general market sentiment is to buy, driving up prices. A bearish market is an exact opposite. With these in mind, what then does bullish divergence cover?
Bullish divergence is a precious technical analysis indicator. It’s not as much a tool as a pattern revealed by tools. It is a situation where the asset price is falling lower than the analysis indicator, potentially predicting the market is gaining momentum. It basically means the actual market price falls below the technical analysis price indicator, causing a “divergence” in a “bullish” direction. A few technical indicators that can identify a bullish divergence are;
- Relative Strength Index: This is an oscillator that works like a scale measuring the direction of the market momentum, as well as its strength. On a scale of 0 to 100, an RSI of 70 and above signifies an overbought signal, while one of 30 and below signifies an oversold signal.
- MACD (Moving Average Convergence Divergence): A situation where the MACD is moving towards a higher price and the asset price is moving towards a lower price shows a divergence, and it means the current market trend is losing momentum. The MACD line is the slower of two Exponential Moving Averages, with the other referred to as the signal line.
- The Stochastic Oscillator: This is a tool used by traders to calculate the speed and momentum of the market by comparing the closing price of an asset to its previous closing prices within a particular timeframe. The signal line of the oscillator works with the indicator line, with the tool also possessing a scale with values from 0 to 100. The percentage indicates the last closing price in comparison with the closing prices over the last 14 days. A market scaled 80 and above is overbought, and a market scaled 20 and below is oversold. The difference between the price chart and the oscillator readings constitutes the divergence.
The direct opposite of a bullish divergence is a bearish divergence. There is also a third type of divergence known as a hidden divergence, where the technical indicator moves in a direction but the price stays put, usually signifying the continuation of the current market trend.
Identifying a bullish divergence could be a really rewarding trading skill to know when to enter a trade to make profits, or when to exit to minimize losses. However, it does not point out specific values or prices to enter or exit the market. It only measures the strength of a trend. Technical analysis indicators that identify divergence patterns are not entirely foolproof as well. Traders must be very careful enough to discern whether the divergence is pointing towards a temporary trend reversal or a total trend shift.
