Divergence and
Bearish Divergence

Introduction

When studying price charts, and looking for a potential change in trend, one useful feature to look for in the charts is that which is known as divergence. This refers to the divergence of the price when compared to a chart indicator — that is, when the price is heading in one direction, say up, while the indicator is heading in the other direction, say down. 

Divergence comes in two variations — bullish divergence and bearish divergence, and each of these types of divergence can be classified as of three different “strengths” — Class A, Class B, or Class C.

Sample 1 - All Ordinaries index (late 2007)

Take a look at the sample chart in the page header above (click on the image for a larger version). This weekly line chart of the All Ordinaries index (XAO) is now a few years old, but it clearly demonstrates the idea, and there are plenty more samples of divergence in more recent charts. Note the following features in this sample chart:

• As the index rises and falls, the Momentum indicator usually rises and falls roughly in sync - most of the time. Except for the period flagged as “A” in this chart.
• During the period indicated as “A”, the index kept running higher through April, May, June and July 2007 to make a Higher High in October, while the indicator failed to make Higher Highs and in fact made Lower Highs down into October.
• This is "Class A" bearish divergence, and warned of underlying weakness in the Australian index. We know that the index then went on to fall more than 50 percent in the following several months. Chartists would not have been surprised, due to this chart known as bearish divergence. See a chart of this fall in the Bear Markets section of the Toolbox.

Divergence - bullish and bearish

The notion of divergence is basically where the price of the index or stock continues to trend in one direction while a chart indicator trends in the other direction. 

Bullish divergence - Basically, this is where the price is making lower lows,
while the indicator is making higher lows. This is an indication of underlying strength building in the stock.

Bearish divergence - Basically, this is where the price is making higher highs,
while the indicator is making lower highs. This is an indication of underlying weakness building in the stock.

Sample 2 - All Ordinaries index (2009)

The second sample here is the weekly chart at right of the All Ordinaries index (XAO) over the period November 2008 to May 2009 (click on the chart for a larger image). This is when the Aussie market bottomed (March 2009). 

The bullish divergence shown in this chart clearly shows the underlying strength building in the index, so the chartists were not surprised to see the index rally.

In this sample we can see that the All Ordinaries index (upper pane) made lower lows as it continued it's down trend in late 2008 and early 2009. But at the same time, the RSI indicator did not make lower lows - in fact it was making higher lows which is bullish divergence.

Sample 3 - Telstra bullish divergence

The third sample is the weekly candlestick chart of Telstra (TLS) at right showing Telstra shares in a downtrend (the upper pane) making lower lows in 2006, while the MACD indicator (lower pane) made a higher low. This is bullish divergence, indicating underlying strength building in the share price. 

The stock went on to increase 36 percent in the following five months.

By the way - also note that the MACD indicator was rising below it's zero line during the period of divergence - another indication of underlying strength building.

Which chart indicators?

The observation of divergence is apparent on a number of technical analysis chart indicators - but which ones? Several are listed with sample charts in Brainy's eBook Article TA-5210 "Divergence" (available to Toolbox Members).

Divergence Class A, B or C?

For a discussion of the differences between class A, class B and class C divergence, see Brainy's eBook Article TA-5210 "Divergence" (available to Toolbox Members).

More details...

More Information

• TA-5210 "Divergence"

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Last revised: 20 June, 2015.