Chart Analysis · Lesson 13 · Advanced
Spotting and Trading Divergences
You identify bullish and bearish divergences and use them as a strong reversal signal, combined with trend confirmation.
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What Divergence Shows
In a bullish divergence, the price falls to a new low, but the indicator only makes a higher, shallower low. The downward pressure is easing, a turn upward becomes more likely. It identifies bottoms.
Where It Counts
Divergence is most useful on the MACD histogram and Force Index (Elder), especially combined with a false breakout. After a price shock, in crypto often a liquidation cascade, it is worth a look.
Read price and indicator and name the divergence.
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The key points at a glance
- Bullish divergence: price makes a lower low, the indicator a higher low.
- Most useful on the MACD histogram and Force Index, especially with a false breakout.
- The histogram measures momentum, not the future, not alone against a strong trend.
Deep dive
Regular vs hidden divergence: the difference
Regular divergence signals a reversal: price makes a new extreme, momentum does not. Hidden divergence is the opposite and a continuation signal. Mix the two up and you short an intact uptrend just because the RSI is losing steam.
- Regular: trade against the short-term move as a reversal
- Hidden: trade with the higher-timeframe trend as a pullback entry
- Class A is the strongest, leave flat Class C divergences alone
Why divergences fail in strong trends
An oscillator measures speed, not direction. In a fresh trend the RSI sticks in the extreme early, and anyone trading against it gets stopped out. A divergence only becomes tradable at the end of an aged move.
- The indicator is in the extreme zone
- A second signal such as a false breakout or trendline break confirms it
- The move you are fading is already aged
Setting up the MACD histogram and Force Index
The MACD histogram (12/26/9) turns before the crossovers and delivers more precise divergences than the MACD line. According to Murphy, a histogram turn is only a reason for an early exit, not for a counter-trend position.
Elder's Force Index combines price and volume and finds bottoms. In crypto, the combination of a liquidation cascade, a false breakout, and a higher low in the indicator is one of the most reliable bottom setups. Practice reading it on the demo exchange.
Sources: Elder, Murphy
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