by Arthur Hill
There are two types of divergences: negative divergences and positive divergences. A negative divergence occurs when the underlying security moves to a new high, but the indicator fails to record a new high and forms a lower high. For momentum indicators, a negative divergence shows slowing upside momentum that can sometimes foreshadow a bearish reversal. Not all negative divergences result in good signals, especially during a strong uptrend. On the Staples (SPLS) chart, the stock formed a higher high in September, but MACD did not exceed its prior high. A negative divergence formed and MACD moved below its signal line (red) recently.
A positive divergence occurs when a security moves to a new low, but the indicator holds above its prior low to form a higher low. For momentum indicators, a positive divergence shows less downside momentum that can sometimes foreshadow a bullish reversal. Not all positive divergences result in good signals, especially in a strong downtrend. On the Sprint (S) chart, the stock formed a lower low in early September, but RSI held above its prior low to form a positive divergence. Also notice that RSI was oversold in mid August and held above 30 in September. The subsequent move above 50 in RSI and the breakout in Sprint confirmed the signal. Sprint as since moved back below its breakout and warrants a reassessment.
Divergences, both positive and negative, can also form in non-momentum indicators like On Balance Volume, the Accumulation Distribution Line, the AD Line and Chaikin Money Flow. On the Expedia (EXPD) chart, the stock moved to a new high in September, but On Balance Volume (OBV) did not confirm with a higher high. A lower high is forming in OBV and the indicator moved below its 10-day SMA. Sharpcharts users can add moving averages to indicators. This smooths the data and helps define direction. To add a moving average, click the green arrow next to "advanced options", which is just to the right of the indicator parameters.
