InvestorQ : I hear a lot about divergences in technical analysis. How can I as a trader take advantage and trade these divergences?
Mahima Roy made post

I hear a lot about divergences in technical analysis. How can I as a trader take advantage and trade these divergences?

Answer
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Aditi Sharma answered.
1 year ago


The normal underlying assumption of technical analysis is that the technical indicators and price action tend to move in tandem. Let us consider a few instances. When stochastic starts heading lower from the overbought zone, the corresponding asset class (equity or commodity or even currency) usually sells off. On the other hand, if the stochastic is climbing out of the oversold area indicates that corresponding asset class (equity or commodity or even currency) could rally from there on. What happens if the technical indicators and the price action show diverse results? That is a possibility and let us look at it.

There are instances when technical indicators and price action seem to be showing different results. Traders refer to these scenarios as divergences and they are extremely important from a trading perspective. Divergences take place when indicators make different highs or different lows. To be specific, higher highs in price and lower highs for the technical indicator constitute a trading divergence. So does lower highs in price and higher highs for the technical indicator also indicates a trading divergence. Meanwhile, lower lows in price and higher lows for the technical indicator or higher lows in price and lower lows in the indicator are also divergences. When such divergences occur, they are a ratification of your original view and you can put your trade accordingly.