Divergence

a very powerful tool but one of the most confusing tools by definition in classical TA since 90% of classical TA just teaches this absolutely wrong by wrong I mean it not providing a true edge

let's start with a few principle steps to bring more clarity into this powerful tool

as usual the devil here is in the details

1. distinction between direction and timeframe

meaning if you use a trend indicator and look for divergences with price trending, divergences are to be expected but are meaningless to indicate a trend reversal, until you look for divergences that far apart that you are looking a time frame higher which might not be trending but being sideways and than the divergence works as a price direction reversal

in short it is essential to be aware with

1. what tool you are measuring a divergence

2. in what environment you are using a divergence

3. in what timeframe you are using a divergence lets look at an example:

identify range or trend in the chosen time frame:

we are looking at the daily chart of the S&P500:

the point in question is marked with a white circle

the definition for trend is:

uptrend= higher highs and higher lows

downtrend=lower highs and lower lows

the following chart shows clearly that for the daily time frame we were in an overall down trend at the time:

when in doubt you can also add a linear regression channel and computation shows you the overall direction:

Ido not want to elaborate on all the endless problems, misinterpretations and simply wrong ways on how to use it but implement solutions right away even not all addressed in detail just yet

zooming into our spot in question one of the most important things is to measure correctly:

we are looking at a POI spot which is the upper bound trend line down (red)for a low risk continuation entry spot in the brief sideways fractal (red box):

the CCI, an oscillator, a tool to be used in sideways markets, provides multiple solutions in this case to avoid getting multiple wrong signals many other tools would provide

precisely measure which price bar lines up with the CCI's highest reading

(white vertical line):

and do the same with the (early) divergence high of the CCI:

draw the price bar highs line and the divergence bar highs and compare:

there is no significant divergence to be found just yet

BUT

one bar further:

the CCI shows an even lower high on the CCI while the price bar shows a higher high:

now the divergence is significant !!!!

and right at the time when you badly need information since the price formation from a candle stick perspective shows a bullish projection for the upcoming session with the bullish doji

while the world expects a high likelihood of prices possibly penetrating the upper trendline especially with the strong trending day prior, the astute divergence trader is aware of the highest odds, which are trend continuation on a directional divergence

one reason why the price decline on the next day is right out of the gate and substantial in size

add this tool to your daily call and your odds of correct future price predictions will in crease massively

I am aware that this example is not in alignment with classical TA but rest assured that the backing data I have used and my over 30 year of looking at these signals and using them is substantiated by large sample sizes for validation that you should at least consider looking at this way of application

I will provide various examples in the future on how to use divergence effectively