THE BEARISH HIDDEN DIVERGENCE

In a bearish HD, price makes a

lower high, but the indicator

makes a higher high. This type

of nonconfirmation is mainly

found during corrective rallies

in a downtrend but may

also occur during retests of a

price top. Bearish HDs signal

potential underlying weakness in a security.

An example of bearish hidden divergence appeared on the

June 1995 cattle chart (Figure 4). Following a steady twomonth

decline, price rallied in April to form point 1. After a

brief decline, price rallied again to form point 2, which moved

the indicator to a higher level than it had been at point 1.

However, price made a lower high at its own point 2. The lower

price high, accompanied by a higher indicator high, produced

a bearish hidden divergence, and prices continued their decline.

In May, another price rally ensued, taking both price and

indicator to their respective point 3s. Because the indicator was

higher at point 3 than at point 2 and the price high was lower

at point 3 than at point 2, point 3 would be labeled as another

hidden divergence.

But this proved to be a false hidden divergence, as price rose

above the point 3 high within the next few days. A false hidden

divergence is similar to a false classic divergence in that

momentum has changed but not enough to produce a major

price change. A trendline drawn from the price top of point 2

4 high. The next bearish HD took place at point 6 where the

indicator rose above its point 5 high, but price failed to take out

its point 5 high. Price then continued to decline to the $18 level.

Figure 6 also shows that not all hidden divergences lead to

large price moves. Let me note here, however, that hidden

divergences generally do help to keep a trader on the right side

of the trend.