Divergence is a concept used in technical analysis to identify a potential reversal or shift in the trend of a financial instrument, such as a stock, currency pair, or commodity. It occurs when the price of the asset and a technical indicator, often an oscillator, move in opposite directions. Divergence can be either bullish or bearish, providing insights into potential changes in market momentum.

There are two main types of divergence:

1. **Bullish Divergence:**
– **Definition:** Bullish divergence occurs when the price of the asset makes lower lows, but the corresponding indicator (usually an oscillator) makes higher lows.
– **Interpretation:** This suggests that while the price is moving lower, the momentum or strength behind the downward move is weakening. It may signal a potential reversal to the upside.

2. **Bearish Divergence:**
– **Definition:** Bearish divergence occurs when the price of the asset makes higher highs, but the indicator makes lower highs.
– **Interpretation:** This suggests that while the price is making new highs, the momentum or strength behind the upward move is weakening. It may signal a potential reversal to the downside.

Common technical indicators used to identify divergence include the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), and the Stochastic Oscillator.

Here’s a brief overview of how divergence is interpreted with these indicators:

– **RSI Divergence:**
– Bullish Divergence: Price makes lower lows, but RSI makes higher lows.
– Bearish Divergence: Price makes higher highs, but RSI makes lower highs.

– **MACD Divergence:**
– Bullish Divergence: Price makes lower lows, but MACD histogram makes higher lows.
– Bearish Divergence: Price makes higher highs, but MACD histogram makes lower highs.

– **Stochastic Oscillator Divergence:**
– Bullish Divergence: Price makes lower lows, but Stochastic makes higher lows.
– Bearish Divergence: Price makes higher highs, but Stochastic makes lower highs.

It’s important to note that while divergence can be a powerful tool for identifying potential trend reversals, it is not foolproof, and false signals can occur. Traders often use divergence in conjunction with other technical analysis tools and consider broader market conditions and fundamentals to make more informed trading decisions.