Hidden Divergence

NEW TECHNIQUES

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Divergence, which is a term that technicians

use when two or more averages or

indices fail to show confirming trends,

is one of the mainstays of technical

analysis. Here’s a new way to use oscillators

and divergence as well as methods

to locate entry levels during a trend.

ost technical indicators

mirror or confirm price

movement. When price

moves up, the indicator moves up; when

price moves down, the indicator moves

down. When prices peak, the indicator

peaks; and when prices bottom, the indicator

bottoms. Sometimes, however, a

discrepancy occurs between price and

indicator movement. That discrepancy

is known as nonconfirmation and can be

seen most clearly on overbought or oversold

indicators as well as on indicators

that move above or below a zero line.

Many traders only learn to recognize

the type of nonconfirmation that occurs

at market tops and bottoms, which is the

classic divergence. But there are other

forms of nonconfirmation I call hidden

divergence (HD) that, when present,

offer additional profit potential.

Hidden divergences are the opposite of classic divergences.

Classic divergence looks for lower low prices accompanied by

higher indicator values at price bottoms and higher high prices

accompanied by lower indicator values at price tops. Hidden

divergences, on the other hand, seek higher price lows accompanied

by lower indicator values during up moves and lower

price highs accompanied by higher indicator values during

down moves. Most hidden divergences signal continuation

moves in the direction of the prevailing trend.

Here are examples of each type of nonconfirmation using

stock and commodity charts. Even though many indicators

display nonconfirmations, I will use a five- to 15-unit (5-15)

price oscillator to illustrate various nonconfirmations. The

oscillator is simply the difference between a five-unit exponential

moving average (EMA) of the closing price and a 15-

unit exponential moving average of the closing price. The

value of that difference fluctuates above and below a zero line.