“Knowing trend reversal through divergence”

When price and momentum are moving in the same direction, they are said to be “in gear”. Momentum measures trend acceleration, i.e. any gain or loss of speed. The common momentum indicators for measuring price movements includes Relative Strength Index (RSI),Moving Average Convergence and Divergence (MACD),Stochastic   and Rate  of Change (ROC) etc.

“However, when momentum does not confirm the price, beware: The prevailing trend may be about to reverse”. Let us know understand the momentum divergence. The disagreement between the indicator and price is called divergence and it can have significant implications for trade management. It is a conflict where indicator is out of sync with the price. The amount of agreement/disagreement is relative, so there can be several different patterns that develop in the relationship between price and the indicator.

The divergences are of two types i.e. Negative and Positive.

Negative Divergence: It is the one when the rising prices are supported by weaker & weaker underlying momentum. The deteriorating momentum represents an early warning sign of some underlying weakness in the price trend. Lead characteristics of momentum indicators are usually more pronounced at market peaks than troughs.

Positive Divergence: It is the one when price lows are lower in a trend but momentum lows are higher. These divergences also occur at market bottom where they are called “Positive”, because momentum hits bottom before price does.