Hidden Divergence by Barbara Star, Ph.D. Divergence, which is a term that technicians use when two or more averages or indices fail to show ...
Hidden Divergence
by Barbara Star, Ph.D.
Divergence, which is a term that technicians use when two or more averages or
indices fail to show confirming trends,
is one of the mainstays of technical
analysis. Here’s a new way to use oscillators and divergence as well as methods to locate entry levels during a trend.
ost technical indicators
mirror or confirm price
movement. When price
moves up, the indicator moves up; when
price moves down, the indicator moves
down. When prices peak, the indicator
peaks; and when prices bottom, the indicator bottoms. Sometimes, however, a
discrepancy occurs between price and
indicator movement. That discrepancy
is known as nonconfirmation and can be
seen most clearly on overbought or oversold indicators as well as on indicators
that move above or below a zero line.
Many traders only learn to recognize
the type of nonconfirmation that occurs
at market tops and bottoms, which is the
classic divergence. But there are other
forms of nonconfirmation I call hidden
divergence (HD) that, when present,
offer additional profit potential.
Hidden divergences are the opposite of classic divergences.
Classic divergence looks for lower low prices accompanied by
higher indicator values at price bottoms and higher high prices
accompanied by lower indicator values at price tops. Hidden
divergences, on the other hand, seek higher price lows accompanied by lower indicator values during up moves and lower
price highs accompanied by higher indicator values during
down moves. Most hidden divergences signal continuation
moves in the direction of the prevailing trend.
Here are examples of each type of nonconfirmation using
stock and commodity charts. Even though many indicators
display nonconfirmations, I will use a five- to 15-unit (5-15)
price oscillator to illustrate various nonconfirmations. The
oscillator is simply the difference between a five-unit exponential moving average (EMA) of the closing price and a 15-
unit exponential moving average of the closing price. The
value of that difference fluctuates above and below a zero line.
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