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What is Divergence in Technical Analysis, and How Does it Affect Crypto Price Prediction?

If you’ve been performing technical analysis for a while, you may have experienced a situation where the price movement of a cryptocurrency or token doesn’t align with your indicator’s values. This is called divergence, and when used well, it can make crypto price prediction much easier for you.

What is Divergence in Technical Analysis - Header Picture
What is Divergence in Technical Analysis – Header Picture

So, in this article, we’ll cover divergence, its types, and the indicators you can use to spot it. Without further ado, let’s dive in.


What is Divergence?

An Example of Divergence by Investopedia
An Example of Divergence by Investopedia

Divergence is a phenomenon that occurs when the price of a cryptocurrency or token moves in a different trend than what an applied technical indicator suggests. It sometimes happens when a crypto’s price goes in the opposite direction of the movement of a technical indicator or even a fundamental indicator such as trading volume. 

It’s important to note that divergence occurs in different financial markets, so it’s not peculiar to the crypto space. Also, divergence is commonly associated with a particular type of technical indicator called oscillators. They include the Moving Average Convergence Divergence (MACD), the Relative Strength Index (RSI), the Stochastic Oscillator, and others. 

Since they measure the speed and strength of price movements, they appear as lines that fluctuate like a token’s price movements. When the actual line representing a price movement moves in a different direction than the oscillator’s line, divergence occurs. 

Divergence isn’t a bad thing in crypto. If anything, it confirms trend reversals, making for better-informed trading decisions. It primarily warns that the current price trend is weakening and about to change direction. 

For instance, if a coin’s price movement has been bearish or dipping for a while and continues going on a steeper dip when the indicator’s low is higher, selling sentiment will soon be exhausted, and a bullish trend is in order.

This is an example of positive divergence, one of the two significant kinds of divergence. While positive divergence indicates that the price of a cryptocurrency may rise soon, negative divergence does the opposite.

A negative divergence occurs when the price is still climbing, but the oscillator moves lower or shows bearish signals. This means that selling sentiment will soon outweigh the current trend, and the cryptocurrency or DeFi asset’s price will drop.

Positive and negative divergence are also called bullish and bearish divergence, respectively. 

While divergence is a good indicator of trend reversals and even sideways price movement, it’s not always reliable, especially for long-term movements beyond 12 hours. Also, many trend reversals occur without divergence. 

So, even though they’re an excellent tool for making crypto price predictions, you shouldn’t rely on them solely.


Types of Divergence

Beyond positive and negative divergence, there are other kinds. They include

  1. Regular divergence
  2. Hidden divergence 
  3. Extended divergence 

1. Regular Divergence

An Example of Regular Divergence
An Example of Regular Divergence

Regular divergence is the most common kind that occurs in the crypto market. It happens when the price movement of a token disagrees with the indicator’s trend. 

That is, when the value of a crypto makes a new low or high, and the corresponding low or high in the indicator isn’t as extreme.

There are two kinds of regular divergence— bullish regular divergence and bearish regular divergence.

  • Bullish regular divergence: This kind of divergence occurs when the cryptocurrency’s price forms a lower low, but the indicator’s or oscillator’s is higher. This kind of divergence usually means that downward momentum or selling sentiment is weakening, and a potential reversal to the upside is imminent.
  • Bearish regular divergence: Bearish regular divergence is the opposite of bullish divergence. It occurs when the underlying value of a cryptocurrency forms a higher peak than the indicator’s. It usually suggests upward momentum weakening, and a bearish trend is potentially in order. 

2. Hidden Divergence

An Example of Hidden Divergence
An Example of Hidden Divergence

Hidden divergence is similar to regular divergence. The significant difference is that it’s harder to spot. It occurs when the price of a token forms a higher high or lower low, and the oscillator’s trend confirms the same pattern with a slight difference.

There are two kinds of hidden divergence — bullish hidden divergence and bearish hidden divergence. 

  • Bullish Hidden Divergence: Bullish hidden divergence occurs when den divergence occurs when price makes a higher low, and the oscillator makes a lower low. This indicates a potential price increase is imminent.
  • Bearish Hidden Divergence: Bearish hidden divergence occurs when the cryptocurrency’s price makes a lower high, but the indicator’s corresponding high is higher. This usually indicates that the cost of the cryptocurrency will experience a downtrend soon.

3. Extended Divergence 

An Example of Extended Divergence
An Example of Extended Divergence

Extended divergence is a bullish or bearish divergence variation that occurs for a longer time. It usually occurs when the market moves sideways, and there aren’t as many highs and lows. This kind of divergence can span for several days or weeks. Typically, traders consider extended divergence signals more significant as they provide confirmation of a trend reversal or continuation over a longer period.


Importance of Divergence

Divergence is essential in technical analysis for the following reasons. 

  1. Trend confirmation
  2. Timing entry and exit points
  3. Identifying overbought and oversold conditions
  4. Risk management

1. Trend Confirmation

Divergence helps to confirm market trends. For instance, if a crypto’s price consistently climbs higher, and the corresponding oscillator also makes higher highs, this confirms the trend’s strength.

2. Timing Entry and Exit Points

Divergence can help you determine appropriate entry and exit points. Since it confirms trend reversals, it tells you the best times to profit from buying or selling a particular token or cryptocurrency.

3. Identifying Overbought and Oversold Conditions

Identifying when buying and selling momentum have peaked is essential for crypto price prediction, and divergence is a crucial indicator for these conditions. For instance, if a DeFi asset’s price is making lower lows, but the corresponding indicator is making higher lows, this is a bullish divergence and may signal that the asset is oversold.

4. Risk Management 

Divergence helps in risk management by providing clues about potential trend reversals. By recognizing divergence signals that suggest weakening momentum, you can adjust your position size, tighten stop-loss orders, or take profits to minimize potential losses or protect gains.


Limitations of Divergence

As helpful as divergence is, it has its limitations. For one, not all price reversals are indicated by divergence. Also, you’ll need to use a couple of oscillators to confirm whether the divergence one oscillator suggests is accurate. 

Furthermore, you can’t always tell when a divergence will be extended. So, if you pick an entry point and the market goes sideways, your trade may take much longer than anticipated.

This is why tools like the Crypticorn Price Prediction Dashboard exist: to provide traders with all the information they need to make trading decisions from one place.

Unlock Your Trading Potential: Enhance Your Strategy with AI-Driven Crypto Price Forecasts
Unlock Your Trading Potential: Enhance Your Strategy with AI-Driven Crypto Price Forecasts

Best indicators to spot divergence with

As we’ve mentioned earlier, the best indicators for divergence are oscillators. The following are the best oscillators for identifying divergence in technical analysis.

  • Stochastic Oscillator
  • Moving Average Convergence Divergence (MACD)
  • Relative Strength Index (RSI)
  • The Volume Oscillator

Conclusion

Divergence is an excellent tool in technical analysis for crypto price prediction. It helps you confirm when a price trend will reverse, making for great buying and selling signals. Still, you must be careful using them, as not all reversals are indicated by divergence. Also, you have to confirm them with multiple indicators.

In this article, we’ve covered divergence and its types. Hopefully, you can identify price trends and their reversals using them.


FAQ

How does divergence work?

When the price of a cryptocurrency or token moves in the opposite direction of a technical indicator, divergence occurs. Simply put, divergence is when a token’s underlying price experiences higher highs or lower lows than what the technical indicator suggests. This phenomenon indicates that a price reversal may very likely happen.

Is divergence bullish or bearish?

Divergence can be either bullish or bearish. If the price of a cryptocurrency goes to a lower low than that of the indicator, a bullish divergence occurs. If it climbs higher than the technical indicator’s, a bearish divergence has occurred.

What is the best divergence indicator?

Personally, we highly recommend using the MACD (Moving Average Convergence Divergence) indicator to spot divergence in the crypto market. The Relative Strength Index and Stochastic Oscillators are also significant divergence indicators.

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