Overview of Trading Divergences
Trading divergences happen when an indicator and price give conflicting signs, leading to possible buy opportunities.
For example, the price of a security might hit a low of a session but the stochastic oscillator reached a higher low, then this might signal a buying opportunity. This is because the price decrease did not correlate with the oscillator, signaling mispricing.
Now if price had reached a higher high but the stochastic oscillator had reached a lower high, then that might signal that price might decrease in the upcoming period. With price surging but the oscillator not as strong, it is more likely that the buying pressure will die off soon.
The other two scenarios in which a divergence occurs is when a higher low with price has been reached, but a lower low in a directional indicator has occurred. This signals that price will likely increase in the future. This is because the new low for the leading indicator wasn't enough to bring the price down with it, signaling strength with the bulls.
The last scenario in which a divergence occurs is when you have a lower high with price but a higher high with a directional indicator. This signals an upcoming decrease in price. This is because the new high in the indicator wasn't able to bring the price to a new high, signaling more strength with the bears.