How to Identify "Hidden Divergence" for Trend Continuation
In the world of technical analysis, identifying hidden divergence can be a powerful tool for traders looking to spot potential trend continuation opportunities. Unlike regular divergence, which often signals a reversal, hidden divergence suggests that the current trend is likely to continue. Let's explore how to recognize and use hidden divergence to your advantage.
What Is Hidden Divergence?
Hidden divergence occurs when the price and an oscillator indicator (like the RSI or MACD) move in opposite directions, but in a manner that suggests the prevailing trend will continue. There are two types:
- Bullish Hidden Divergence: Price makes a higher low, but the oscillator makes a lower low.
- Bearish Hidden Divergence: Price makes a lower high, but the oscillator makes a higher high.
This setup indicates that the underlying momentum is still aligned with the trend, despite the apparent contradiction on the surface.
How to Spot Hidden Divergence
Here’s a step-by-step guide to identifying hidden divergence:
- Select an oscillator indicator—RSI, MACD, or Stochastic are common choices.
- Look for a clear trend on the price chart. Hidden divergence only applies in trending markets.
- Compare price and indicator swings: For bullish divergence, check if the price makes a higher low while the oscillator makes a lower low. For bearish divergence, look for a lower high in price with a higher high on the oscillator.
- Confirm with other signals: Use candlestick patterns or moving averages to increase confidence in the signal.
Why Hidden Divergence Works
Hidden divergence often appears during pullbacks in a strong trend. The oscillator’s behavior reflects that momentum is still in favor of the main trend, even if the price momentarily moves against it. This makes it a useful tool for trend-following traders who want to enter during retracements.
Practical Example
Imagine an uptrend in a stock’s price. During a pullback, the price forms a higher low than the previous swing low. However, the RSI forms a lower low. This is bullish hidden divergence, suggesting the uptrend is likely to continue.
Risk Management and Confirmation
While hidden divergence is a strong signal, it’s essential to use proper risk management. Always set stop-loss orders and confirm with other indicators or chart patterns. No single signal is foolproof, and the market can be unpredictable.
Conclusion
Learning how to identify hidden divergence can give traders an edge in trending markets. It allows you to spot opportunities to join the trend at favorable points, increasing your chances of success. Remember to use it in conjunction with other tools and always manage your risk.
Pro Tip: Practice identifying hidden divergence on historical charts before applying it to live trading. This will help you build confidence and improve your timing.