Online Trading Concepts


Momentum Divergences


  1. Momentum Defined
  2. Momentum Divergences

Identifying divergences between price and technical indicators can be an important aspect of technical analysis trading. Bullish divergences might signal a trader to exit their short position; similarly, bearish divergences could warn that prices could correct and that it might be advisable to exit any longs.

In the chart below of the S&P 500 exchange traded fund (SPY), Momentum divergences can be seen:

momentum price divergences

The first bearish divergence occured when price formed a double top formation. The Momentum indicator confirmed when price of the S&P 500 ETF failed to make a higher high.

The next divergence was a bullish divergence, where price made lower lows, yet the momentum indicator made higher lows. This signaled that the recent downtrend was losing steam and that a bottom could be forming.

The last divergence occured because the S&P 500 ETF was increasing, but at a decreasing rate. The momentum indicator shows this perfectly, by making lower highs over the course of about 15 stock trading days.

Just because a stock trader or futures trader sees a divergence doesn't necessarily mean that they should reverse their stock or futures trade. Divergences are attempts at warning of potential reversals. A more concrete signal, like a trendline break might have been a great signal in the last example. Nevertheless, in this particular example, the Momentum indicator offered the stock trader plenty of time to reduce the size of their long stock position.

A similar, and arguably superior tool for measuring momentum is the Rate of Change indicator (see: Rate of Change).

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