Hidden Divergence: What It Is and How to Use It in Trading

Basics of Hidden Divergence

What is Hidden Divergence?

Hidden divergence is a key technical signal that appears during a trend continuation.

This signal can be confirmed using technical indicators called oscillators.

Oscillators are indicators that show overbought or oversold conditions in the market based on price fluctuations and past price movements.

Common oscillators include RSI (Relative Strength Index), Stochastic Oscillator, and MACD (Moving Average Convergence Divergence).

Hidden divergence occurs when the price makes a new high (or low) while the oscillator fails to make a new high (or low).

This is a crucial sign that suggests the price is likely to continue its current trend.

While hidden divergence is a strong signal for trend continuation, it doesn’t guarantee that the trend will continue.

Difference from Regular Divergence

Regular divergence is a signal that suggests a trend reversal.

Regular divergence occurs when the price makes a new high (or low) while the oscillator makes a new low (or high).

This is a sign that suggests a potential trend reversal.

Hidden divergence suggests trend continuation, which is the opposite of what a regular divergence indicates.

How to Spot Hidden Divergence

Analysis with Oscillators

To spot hidden divergence, you overlay an oscillator on your chart and check if the price movement and the oscillator’s movement are moving in opposite directions.

For example, if the price makes a new high but an oscillator like the RSI or Stochastic Oscillator fails to make a new high, a hidden divergence may be occurring.

Conversely, if the price makes a new low but the oscillator fails to make a new low, a hidden divergence may also be occurring.

Confirmation of Trend Continuation

While hidden divergence suggests a trend will continue, it’s not a foolproof signal.

Therefore, it’s important to use it in conjunction with other technical and fundamental analysis.

For example, you can use other technical indicators like moving averages or Bollinger Bands.

It’s also crucial to consider fundamental analysis, such as economic indicators and company performance.

Practical Use of Hidden Divergence

Hidden Divergence with RSI

The RSI is an indicator that shows overbought or oversold conditions in the market.

An RSI above 70 is considered overbought, while an RSI below 30 is considered oversold.

Hidden divergence often occurs when the RSI is in an overbought or oversold state, suggesting a potential trend continuation.

For instance, if the price makes a new high while the RSI fails to make a new high and is above 70, a hidden divergence may be occurring.

In this case, the trend is likely to continue, and it can be considered a buy signal.

Using the Stochastic Oscillator

The Stochastic Oscillator compares a closing price to its price range over a certain period to show overbought or oversold conditions.

A reading above 80 is considered overbought, while a reading below 20 is considered oversold.

Hidden divergence often occurs when the Stochastic Oscillator is in an overbought or oversold state, suggesting a potential trend continuation.

For example, if the price makes a new high while the Stochastic Oscillator fails to make a new high and is above 80, a hidden divergence may be occurring.

In this case, the trend is likely to continue, and it can be considered a buy signal.

Important Notes for Trading

Avoiding False Signals

Hidden divergence is a signal that suggests a potential trend continuation, but it’s not a guarantee.

Therefore, it’s possible for the price to reverse even after a hidden divergence appears.

This is known as a “false signal” or “whipsaw.”

To avoid false signals, it’s crucial to use hidden divergence in conjunction with other technical and fundamental analysis.

Additionally, you should carefully observe the price action after a hidden divergence occurs.

If you see signs of a price reversal, you should exit your position immediately.

The Importance of Setting a Stop-Loss

Risk management is extremely important in trading.

Since the price can reverse after a hidden divergence appears, it is essential to set a clear stop-loss level.

A stop-loss level is typically set at a certain distance from the price where the hidden divergence occurred.

By setting a stop-loss, you can minimize potential losses if the market moves against your prediction.

The Significance of Hidden Divergence

Hidden divergence is an important technical signal that suggests a potential trend continuation.

By understanding and using hidden divergence, you can increase your trading success rate.

However, hidden divergence is not a standalone solution.

It’s crucial to use it in combination with other technical and fundamental analysis.

Additionally, the price can reverse even after a hidden divergence appears.

Therefore, it is important to carefully observe the price action after a hidden divergence occurs.

By understanding hidden divergence and using it appropriately, you can build a more effective trading strategy.

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