Forex divergence is a powerful tool that can help traders spot potential trend reversals or continuations. It occurs when the price of a currency pair moves in a different direction than a technical indicator, such as the MACD or RSI. Traders can use divergence to identify potential trading opportunities, but it’s important to understand the different types of divergence and their strengths.
1. Regular Divergence
Regular divergence occurs when the price of a currency pair makes a higher high or lower low, but the corresponding technical indicator fails to make a higher high or lower low. This suggests that the momentum of the price is weakening, and a reversal may be imminent. Regular divergence is considered a strong signal because it indicates a shift in market sentiment.
For example, if the price of GBP/USD makes a higher high, but the RSI fails to make a higher high, it could be a sign that the uptrend is losing steam and a reversal is likely to occur.
2. Hidden Divergence
Hidden divergence occurs when the price of a currency pair makes a lower low or higher high, but the corresponding technical indicator makes a higher low or lower high. This suggests that the momentum of the price is strengthening, and the trend is likely to continue. Hidden divergence is considered a weaker signal than regular divergence because it indicates a continuation of the current trend rather than a reversal.
For example, if the price of USD/JPY makes a lower low, but the MACD makes a higher low, it could indicate that the downtrend is likely to continue.
3. Reversal Divergence
Reversal divergence occurs when the price of a currency pair makes a higher high or lower low, but the corresponding technical indicator makes a lower high or higher low. This suggests that the momentum of the price is shifting in the opposite direction, and a reversal may be imminent. Reversal divergence is considered a strong signal because it indicates a complete shift in market sentiment.
For example, if the price of EUR/USD makes a higher high, but the RSI makes a lower high, it could be a sign that the uptrend is losing steam and a reversal is likely to occur.
4. Convergence
Convergence occurs when the price of a currency pair and the corresponding technical indicator move in the same direction. This suggests that the momentum of the price is strong and the trend is likely to continue. Convergence is not considered a divergence signal because it does not indicate a shift in market sentiment.
For example, if the price of AUD/USD and the MACD both make higher highs, it could indicate that the uptrend is likely to continue.
In conclusion, understanding the different types of divergence and their strengths is essential for traders who want to use this powerful tool to their advantage. Regular divergence and reversal divergence are considered strong signals, while hidden divergence is considered a weaker signal. Convergence is not considered a divergence signal because it does not indicate a shift in market sentiment. By using divergence in conjunction with other technical analysis tools, traders can increase their chances of making profitable trades in the forex market.
