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What is divergence analysis?

What is divergence analysis?

The analysis of convergence and divergence between indexes and other data seeks to find leading indicators where there is confirmation or non-confirmation of trends.

Dow Theory was one of the first examples of such thinking. Charles Dow would watch the movements of Industrials and the Rail and compare the uptrend or downtrend of each.

Where trends do not line up (e.g., one is trending downward with lower troughs and the other has “higher lows”) there is “divergence”, and non-confirmation of what was thought to be a trend in one index.

This has been shown not to be completely reliable as a trading signal, but for analysis that bridges the gap between fundamental and technical, it can be useful. Dow looked for the Primary Trend that would over-arch the shorter trends and last a few years.

The analysis of convergence and divergence is used in many technical methods used today for short-term and intraday trading. When a price trend is diverging from an indicator or moving average line, it could mean that a reversal is nearing.

The MACD and RSI are examples of charts used to look for divergence.

Keywords: technical analysis, trading signals, downtrend, peak, trough, MACD, trends, uptrend, Relative Strength Index (RSI), primary trend, Dow Theory, confirmation, non-confirmation, fundamentals, reversal,