How to use divergences in technical analysis of cryptocurrency?
Everyone knows that divergences can be bearish and
bullish, but how many types of divergences can you name?
The correct answer is three.
The term divergence is quite common and is used in
mathematics, physics, biology, linguistics, but its essence is the same
everywhere and comes from the Latin divergo - I deviate.
In technical analysis, divergence (or in the trading jargon
- diversion) means the divergence of the direction of the indicator and the
price chart.
The value of divergence in technical analysis lies in the
fact that, unlike most signals, diversion is leading.
The essence of this signal is simple, if it appears, then
there is a possibility of a trend change in the near future, or, at least, the
market goes sideways.
Therefore, a bearish divergence will indicate a price
reversal downward, and a bullish divergence will indicate a change in direction
upward.
The divergence signal works on all timeframes, but, as
with most signals, the law of subordination applies, and the divergence on a
higher timeframe is stronger than on a lower one.
Speaking directly about the cue ball, in my practice I
can say that the most suitable scale for catching diverters is 12 hours.
It's hard for me to explain why, but it is on it that
these signals work most effectively.
To track down divergence signals, I use a whole set of
oscillators at once, such as:
- Chaikin
oscillator
- DeMarker
- MACD
- Stochastic
- RSI
- Volume Oscillator.
Why exactly
they?
Because each of them is unique and has its own
characteristics and sensitivity threshold in certain market conditions.
You can use
any other oscillator with which you are most comfortable to work, my main task
in this post is to tell you about the very nature of the “Divergence” signal
and how to read it correctly on the chart.
So, as I said, there are only
three types of divergence, these are:
- normal
(against the trend),
- hidden (trend
following),
- extended.
Also, do not forget that divergence acts
only until the next peak forms, after which it already loses its weight.
An example of a common
divergence (against the trend)
In the chart
above, we can see a good example of a common, Bearish divergence. This
divergence is also called divergence against the trend.
The name itself contains the essence of this signal.
On the chart above, we can see that, despite the updating
of historic highs within the bullish trend, the Chaikin, Volume, RSI
oscillators show peaks below the previous ones.
For clarity, I marked this signal with blue arrows.
As can be seen from the history of the movement, this
signal worked 100%, and the people who followed this signal left the market in
time, selling their bits at historical highs.
in the case
of a regular Bullish divergence, the signal works on the same principle, i.e.
the indicator, even though the market updates the lows, will show more positive
extremes.
An
example of a hidden divergence (trend following)
In the chart
above, we see a good example of reverse divergence, which is also called
“hidden” or “trend following”.
Beginners often confuse bearish “hidden” with regular
“bullish” divergence, which is why they make fatal mistakes and enter longs,
when, on the contrary, it is necessary to consider the option with short
positions.
In the chart above, on the DeMarker, MACD and RSI
indicators, this insidious, BEAR hidden divergence is especially clearly
visible.
Its essence is opposite to the usual diversion - here the
oscillator updates its peaks when the price chart cannot do this.
As you can see, this signal also worked with a bang, and
the market followed the signal and went into correction.
For a Bullish hidden divergence, the opposite is true -
the indicator updates its lows when the price chart can no longer do this.
Extended
divergence example
Extended
divergence is often found during sideways market movements when there is no
pile of highs and lows, as well as during the formation of a "double
bottom" or "double top" pattern and serves as an excellent
confirmation signal of a trend reversal.
In this case, you need to monitor what value the oscillator takes when it reaches the corridor wall in the sideways.
This signal is called an extended Bullish divergence.
Extended BEAR divergence follows the same rules and occurs when the highs are at the same level, but the oscillator failed to show re-reaching past values and drew highs below the previous ones.
What now?
To objectively
assess the situation and make an analysis for the presence of divergences, you
need to view a trading instrument on all timeframes, from weekly to hourly
We see that the volume oscillator has already begun to renew its highs, despite the fact that the market is still going down.
However, other indicators do not give strong reversal
signals.
And this means that the small pullback that is
happening now may just be the result of those very single bursts of our volume
oscillator.
At 6 o'clock, the picture is even more depressing.
As you can see in the
chart above, we have a bearish diversion on Chaikin and Volumes, which is
already a fairly serious bid for a corrective movement.
At four o'clock, the bearish sentiment is confirmed by DeMarker.
Since the search for
divergences occurs when comparing the extremes on the price chart and
indicators, for greater clarity I recommend using the Zig Zag, it highlights
local extremes on the price chart, which makes analysis easier for a beginner.
At the same time, please
do not forget that when looking for divergences in a bearish trend, we compare
the lows, and in a bullish trend, the highs.
In this case, the
divergences themselves should be considered only as a confirming, additional
signal for your trading strategy.
Entering the market based
on only a divergence signal is a big risk!
A good symbiosis of
divergence analysis with trading strategies is an example of using this
analysis when trading in a channel.
For an example, see the
chart above.
Now the market is in a
descending channel, and a bearish divergence at 4 o'clock indicates a small
probability of breaking this channel upwards, therefore, on a rebound from the
upper border of the channel, you can open short positions with the obligatory observance
of risk management and setting stop-losses.
Good luck and good profits
to everyone!
