Divergence
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Divergence is when the price shows trending moves while the corresponding oscillator shows no trending moves.
It is used with the market structure for potential trend continuation or trend reversal. It tells you the status of the momentum of a trend whether going weak or is strong. It is not at all recommended to use it as the only signal to increase your odds of expectation of a change in direction/trend.
So, divergence patterns occur when the trend is weakening or when there is a weakening of price retracement. The divergence between the price swing and oscillator is an important signal for loss of momentum in the trend and potential reversal can be expected.
Divergence is measured with the help of oscillators which are momentum indicators used in technical analysis, whose fluctuations are bound by some upper and lower bands. When oscillator values approach these bands, they provide overbought or oversold signals to traders.
We recommend using an “Awesome Oscillator” (AO) to measure divergence. In order to do that we compare the tops and bottoms of price with the tops and bottoms of the AO. So, if the price as shown in the picture below, is in an uptrend for instance and the price is making a higher high compared to the previous high and the oscillator is showing a lower high compared to the previous peak/high then there is a divergence and indicates a possible weakening of the trend and a possible bigger pullback or reversal. The blue-shaded rectangular area marks the whole of the impulsive swing legs and within this area, you mark the corresponding highest peak in the oscillator shown with circles in the oscillator.
Divergence in higher time frames as well as lower at the same time is a better sign to expect the trend to finish and turn or fully reverse.
When to Look for Divergence?
In 3 wave Corrective or Impulsive Pattern, look for divergence between the 2 impulsive waves if the pattern is Regular as shown below:
In 5 wave Corrective Pattern, look for divergences between the last two Impulsive waves
In 5 wave Impulsive Pattern, look for divergence between the last two Impulsive waves, wave 3 and wave 5 as shown below:
The use of an Oscillator is to identify possible completion of a corrective structure in the case of regular or 5-wave trending correction and also in the case of 3 or 5-wave impulsive wave structure.
When there is a divergence between the oscillator peaks (in an uptrend) / bottoms (in a downtrend) and their corresponding impulsive waves, a possible completion of the structure can be expected. Divergence indicates a loss of momentum in the ongoing trend.
Take the lowest bottom in the oscillator (as shown in the green circle in Fig. 24 below) that comes within its corresponding impulsive wave (as shown with the green line in the price chart).
There should be at least one crossover between the two bottoms of the oscillator. (as shown with blue boxes).
The Oscillator is only a tool. In a corrective structure if 3 waves are done and no divergence, it can mean one more down but doesn’t negate that the corrective structure is done and can also resume the trend.
