What Is Hidden Divergence and How Is It Used?

Technical analysis is a widely used methodology in financial markets to forecast price direction. It involves studying past market data, such as price and volume, to identify patterns and trends. This approach assumes historical trading activity can indicate future price action. Technical analysts use various tools, including charts and indicators, to identify potential trading opportunities. The goal is to anticipate outcomes based on historical price behavior, helping to identify favorable entry and exit points for trades.

Understanding Divergence

Divergence in technical analysis occurs when an asset’s price and a technical indicator move in opposing directions. This discrepancy signals a weakening of the current trend and can indicate a potential change in market direction. It happens when the market forms an extreme high or low, but the indicator does not follow. There are two types of regular divergence: bullish and bearish. Bullish divergence occurs when the asset’s price forms lower lows, but the indicator shows higher lows. This suggests that despite falling prices, selling pressure is diminishing, signaling a possible upward reversal. Conversely, bearish divergence occurs when the price makes higher highs, but the indicator forms lower highs. This pattern indicates that underlying upward momentum is weakening, suggesting a potential downward reversal. Regular divergence signals a potential trend reversal, suggesting the existing trend might be nearing its end.

Defining Hidden Divergence

Hidden divergence is a type of technical analysis pattern that signals a continuation of an existing trend, unlike regular divergence which warns of a potential trend reversal. It helps confirm the strength of an established trend, allowing traders to identify potential entry points. The term “hidden” refers to its less obvious nature compared to regular divergence, as price action might initially seem to contradict the indicator’s signal. For bullish hidden divergence, the price makes a higher low while the indicator forms a lower low. This suggests that even after a temporary dip, underlying bullish momentum remains strong, and the uptrend is likely to resume. Conversely, bearish hidden divergence occurs when the price forms a lower high, but the indicator makes a higher high. This indicates that despite lower price highs, underlying bearish pressure is still present, and the downtrend is expected to continue.

Identifying Hidden Divergence

Spotting hidden divergence on charts involves comparing price action and momentum indicators. Common indicators include the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), and the Stochastic Oscillator. These tools measure the speed and change of price movements, providing insights into market momentum. To identify bullish hidden divergence, look for an asset in an uptrend where the price forms a higher low. Simultaneously, observe the oscillator to see if it forms a lower low during the same period. This contrasting movement suggests the trend’s momentum is robust despite price retracement. For bearish hidden divergence, identify an asset in a downtrend where the price makes a lower high. Then, check if the oscillator forms a higher high, indicating continued underlying selling pressure even with a temporary price rebound. Drawing trendlines on both the price chart and indicator can help visually confirm these patterns.

Interpreting Hidden Divergence

Hidden divergence provides insights into the likely continuation of an existing trend. When identified, it signals that a temporary pullback or consolidation within an established trend is nearing its end. This suggests the original trend is expected to resume with renewed strength. Traders and investors can utilize this signal to confirm the prevailing trend’s strength. It helps find opportune entry points, particularly after a minor correction, allowing participation in the established trend’s direction. For instance, a bullish hidden divergence in an uptrend suggests a dip is a buying opportunity before the upward movement continues. Conversely, a bearish hidden divergence in a downtrend might indicate an opportunity to enter or add to a short position as the downtrend is likely to persist.