Bearish divergence
| Bearish divergence |
|---|
| See also |
Bearish divergence is the opposite of bullish divergence. It occurs when the price is rising while the momentum is declining. The pattern looks for higher high prices and lower low oscillator values. Bearish divergence happens when the market is preparing for a corrective decline. In the beginning of the bearish buildup, price fails to show any sign of corrective action as weak investors are buying from strong investors. When more strong investors exit the market and the distribution is finally over, the price will fail[1].
Bearish divergence occurs above the zero line on the positive side of the histogram. In an uptrend, prices make many new highs and the histogram confirms the trend by making new higher peaks above the zero line, mirroring the share price. Bearish divergence occurs when the market makes a new high and the histogram fails to reach a higher peak than its last. This contradiction indicates that a divergence is present, which suggests a weakening trend[2].
Direction of the trend
Bearish and bullish divergence are determined solely from the directional relationship between peaks and troughs, or slope, are the observed wave degree between the two data series, irrespective of the direction of the trend at the next higher wave degree.
Bearish (or negative) divergence implies that price will either:
- Reverse to the downside
- Continue declining to the downside
Bullish (or positive) divergence implies that price will either:
- Reverse to the upside
- Continue rising to the upside
With respect to reverse divergence, price is expected to continue in the direction of its current larger trend, moving in the opposite direction to that of the supporting data series. Unfortunately, there are two approachers in reverse divergence with contrary outcomes. In either case, if the supporting data series is moving to the upside, price is expected to move to the downside, and we say that we have reverse bearish divergence. Conversely, if the supporting data series is moving to the downside, price is expected to move to the upside, and we say that we have reverse bullish divergence[3].
Divergence between HPI and price aborts
Important divergences develop over the course of several weeks. A divergence that takes two months to develop is more powerful than the one in which two weeks passed between the tops or bottoms. Pay attention to the differences in the height of the adjacent tops or bottoms. If the first top or bottom is far away from the centerline and the second top or bottom is near that line, that divergence is likely to lead to a greater move.
Bearish and bullish divergences of HPI often have long lead times. Once you have identified a potential turning point using an HPI divergence, lean on short-term oscillators for more precise timing. If a divergence between HPI and price aborts, and you get stopped out, watch closely- you may get an even better trading opportunity if a regular divergences consist of three lower bottoms in prices and three higher bottoms in HPI. Triple bearish divergences consist of three higher tops in prices and three lower tops in HPI. They occur at some of the major turning points in the markets[4].
Footnotes
References
- Elder A. (1993), Trading for a Living: Psychology, Trading Tactics, Money Management, John Wiley & Sons, New York.
- Lee R.M, Tryde P. (2012), Timing Solutions for Swing Traders, John Wiley & Sons, Hoboken.
- Lim M.A. (2015), The Handbook of Technical Analysis, John Wiley & Sons, Milton.
- Pollard J. (2011), Smart Trading Plans, John Wiley & Sons, Milton.
Author: Michał Duch
