Are you new to trading? Learn all about bullish divergence using this short guide.
What Is Divergence?
Traders use divergence to know how prices move and indicate their position in the trading market. Divergence will also help predict future prices and market trends so investors can make decisions about buying and selling stocks.
You will encounter two types of divergence once you start trading. Typically, investors will be dealing with bearish and bullish divergence. In this article, you can find out about bullish divergence and how to trade using it.
What Is Bullish Divergence?
Bullish divergence happens in three different circumstances:
- When prices reach a new low and the oscillator reaches a higher bottom than the previous decline.
- When prices reach the double bottom and the oscillator goes to a higher second bottom.
- When prices reach a new low and the oscillator hits double bottom.
The divergence indicates the end of a downtrade and the start of higher prices.
You can also classify bullish divergence into regular and hidden divergence. The regular divergence lets you know that you need to sell your shares, while the hidden divergence communicates continuous investment.
Traders observe regular bullish divergence when the price chart is in lower lows, indicating a downtrend, but the indicator shows higher lows instead. The divergence usually occurs when the starting prices are quite risky. Thus there are new lows in the prices. Yet, the indicator did not show any new lows, but higher lows appeared.
On the other hand, the hidden bullish divergence has a price chart that forms a higher low, but the indicator shows lower lows. Sometimes, the price chart indicates a double bottom low, yet the oscillator has lower lows. The pattern formed gives an upward correction that you can use to infer a continuation with an investment.
Using Reliable Indicators for Trading Divergences
Indicators will help you know the divergence. It would not be easy to trade divergence without another indicator. You can learn which indicators to use in different circumstances.
Here are the steps to use an indicator:
- Apply the indicator on the price chart
- Draw a line between recent highs or lows in prices
- Evaluate whether the price and oscillator moves differently from each other
- If there are discrepancies, determine the divergence
- Confirm the indication of the divergence and be careful with misleading alerts
Moving Average Convergence Divergence (MACD)
MACD is an indicator using a lagging method which usually occurs late. The price and indicator have a direct relationship where the trend follows each other. You have to take your time to properly watch the trend and determine if there is any crossover between the price and indicator.
Stochastic Oscillator
A stochastic oscillator is an indicator of overbought and oversold conditions in the market. The oscillator uses two lines that form tops and bottoms.
Relative Strength Index (RSI)
RSI is a recommended good indicator. RSI is also an indicator of overbought and oversold conditions in the market. The oscillator uses a solid line that moves up and down.
Trade With Bullish Divergence
If you’ve followed the steps on using a good divergence indicator, you’re ready to use the bullish divergence in all your trades. You can be smart enough to know when to buy and sell. Here is how you can benefit from the divergence.
Take Profit
Bullish divergence doesn’t guarantee an entry and exit point in trading. However, you can use it as a reference to take profit instead. If there is a price reversal, you need to sell out your stocks.
For example, the price is at lower lows, but the oscillator records a higher low. You can determine a regular bullish divergence which states that there is a reversal. Then, your next step is to begin selling your stocks.
Stop-Loss
If you’re quite conservative with your money, you can use divergence to avoid big losses with your investments. In a bullish divergence, you can count on the last bottom of the chart and place the stop-loss. If the price level reaches the stop-loss level, the trading is automatically stopped to avoid big losses.
Recover With MACD
You can use MACD to get a divergence signal. If there is a hidden bullish divergence, you know that you can continue your investment and expect the price to rise still. You can recover any lows and invest for the long term.
An example of a hidden bullish divergence is when the price is upward and recorded an important correction. The price resumed its initial upward direction and recorded another pullback. The price fell to record new lows and closed higher than the previous downward. However, the oscillator recorded a lower low (hidden divergence) and indicated a possible upward movement.
Final Thoughts
Trading is quite tricky. In the world of investing, the more you know, the better chances you have at gaining profit and maintaining your position. Having a background on divergence and its indicators greatly helps you know when to buy and sell your stock investments. Make sure to double-check your inference on the indication of bullish divergence because you can always encounter false alerts that you may regret.