What is divergence in crypto and how to use It?
A signal called “divergence” helps to indicate a possible reversal in the actual price that may happen soon.
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Divergence is one of the most powerful reversal signals in indicator technical analysis. Divergence is when the price of the asset is moving in the opposite direction of the oscillator indicator. Divergences are classified into two types: bearish and bullish.
Types of divergences
Bearish divergences occur when prices rise to a new high but an indicator stops at the very same level.
Bearish divergence on the Bitcoin chart. Source: Tradingview
On the one hand, we see that the BTC price is rising. On the other hand, the indicator shows that the current price trend is weakening and that the uptrend is sustained solely by inertia. The bulls are running out of steam, which means that a correction is on the way. After receiving such a signal, a trader can start looking for entry points for a short position.
In the spring of 2021, a similar bearish divergence appeared on the Bitcoin daily chart, just before BTC fell to $30,000
A bullish divergence is a mirror situation when the price of an asset hits new lows, but the indicator does not.
Bullish divergence on the Bitcoin chart. Source: Tradingview.
On the chart, we can see that the price of Bitcoin is falling and reaching new lows. At the same time, the indicator shows that the price moves in the opposite direction of the current trend. This situation can be interpreted as a signal of a possible reversal in the actual price that may happen soon. After receiving such a signal, a trader can start looking for entry points for a long position.
Divergence in trading
Divergence is most often detected and analyzed by traders using MACD and RSI, but other indicators, both trend and oscillators, are also useful.
The reversal zone is most easily identified by the maximum and minimum values of the asset price chart and indicators. The oscillator signals that the current trend is changing, while the asset price continues to move in the trend's direction and hits extremes. In this case, you should open a position opposite to the current trend direction.
Learning how to spot divergences is a rather useful skill for any trader that allows them to make more balanced decisions in trading. However, as with any other signals, it is important to wait for confirmation before entering a trade: for example, a breakout of the next strong support or resistance level.
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