When looking at a chart with an oscillator attached to it, one doesn’t have to wait a long time before a divergence between the price and the indicator reaveals itself. Also when looking at history data one can see that after a divergence, there is often a change in the trend, which makes many of us (i guess) believe that divergences is a powerfull tool.
Is this just a random consequence of how the indicators are made? Or are there really any predictive values in divergences?
I was hoping for someone (ClarkFX?) to shed some light on this topic.
Divergence can be used as a measure to determine your bias. However just like anything else, a signal by itself doesn’t complete a trading system. Your enter and exit are likely more important.
With any indicator, it is prudent to use more than on reasoning to enter the trade.
The 4 words in your thread are extremely thought provoking.
Many years ago a trader studied the markets, he recognized the power of divergence, long before the existence of oscillators.
At the outbreak of WW2 the stock market, after taking a small fall began to rise, all sectors rose with the exclusion of one - steel.
This was divergence, steel should have been rising, the trader did not buy steel, many months later it emerged that the UK and CAD govts had been selling their steel holdings.
Most recently, have a look at the S&P at close one week ago, on Fri Mar 13. It made on hr1 what many call at double bottom, it was at a low.
Then, imagine this, you were long the S&P, you felt deflated because of the fall on Friday, you had gone long on Thursday amidst all the euphoria of rising prices.
Then you checked the Dax - what is this strange thing, it is making new highs, you decide not to exit the long S&P at a loss after all, there is divergence.
Divergences work sometimes, not always, because they are based on contrarian theories. You will find plenty of divergences on oscillators, because they will always lag behind the price and the price never rises or drops in a straight line, therefore, they will correct in the direction of the oscillator only to see that the oscillator is now heading in the direction of the previous price trend. It is all about price swings.
+1. You should never act based on one single signal. While there is no right amount of how many signals you should have before entering a trade I think everyone can agree that one signal is definitely not a trading signal.
Divergence is pretty interesting. I’ve always found its mechanics intriguing. Divergence can be a sign of trend reversal as well as hint to a continuation of the prevailing trend (hidden vs. regular divergences). What I’m interested in is what the divergence actually means. What I’m referring to primarily applies to price vs. indicator divergences (oscillators), not intermarket (although I’d say some characteristics apply). Price series have a range of [0, ∞) whereas most indicators are standardized within a certain range ([0, 100], [0, 1], [-1, 1], etc). Indicators are simply a derivative of price, measuring the sensitivity of price movements (relative to recent prices). Going with this thought process, one could think about the highs/lows of indicator values as a way to gauge magnitude of price movements. When we see price making higher highs, we are expecting higher highs on oscillators. When this fails to happen, then we could deduce that something is not right. We could also say that there is a market inefficiency at that specific price and time. As traders, I would say most of us are looking to profit off these market inefficiencies. That is just a very basic explanation. The specific oscillator formula plays an important role in terms of making interpretations. There are also factors that could create false readings.
Anyways, the main point is, I believe divergence is something to watch for and can be used as a warning for future price movements. Divergence signals are simply market inefficiencies. I would never enter a position based on divergence alone; always have some sort of confluence. The specific indicator and its settings does play an important role in interpreting divergence signals. I have reason to believe longer period oscillators will give more reliable divergence signals, but I’ll keep this post pretty basic for now.
I can understand if what I said doesn’t make any sense. I literally sat here for a couple hours trying to come up with a clear response, but my brain thinks in weird ways sometimes. But I hope it helps you with whatever you are doing (I assume you are working on something more specific).