Definition of ‘Divergence’ – When the price of an asset (or an indicator) index or other related asset move in opposite directions. In technical analysis, traders make transaction decisions by identifying situations of divergence, where the price of a stock and a set of relevant indicators, such as the money flow index (MFI), are moving in opposite directions (thank you Investopedia).
We all see divergence a little differently depending on what you trade and what you watch. Some traders look for divergence within a specific area of focus (for example if the price of gold is skyrocketing, but the gold miners are taking a bath) and some (like myself) look for divergence across markets (divergence when I see both equities going down as well as the dollar – as well as gold!). Obviously in a situation like this – something isn’t right.
Divergence can often signal that a significant change in direction is in store – for at least one of the assets involved.
If you’ve been following the price of gold as of late, you will see that it has come down considerably in recent days. If you’ve been following the dollar you’ll notice that it too (over the past 3 days) has been falling alongside gold – as well market leader Apple Inc. – down more than 50 bucks over the same time frame.
Ask yourself – if gold (and Apple) are priced in dollars…and the dollar is falling…shouldn’t the price of these two assets be going up? – something’s got to give.
Looking out at larger time frames (I am talking a weekly chart) often helps in spotting the “odd man out”. As well – a good solid “recap” of the fundamentals driving price action in each given asset.
- Ben is printing dollars like confetti – that’s not changing anytime soon. (dollar down)
- Demand for gold is (and always will be) high – I don’t see that changing anytime soon. (gold down?….ummm)
- Apple is the most valuable company well……..ever! (apple down?…ummm)
In this example it looks far more likely that both gold and Apple are merely “pulling back” with larger uptrend to continue as the dollar continues its slide into the basement. The divergence here (and how to trade it) points to buying opportunities in both equities and gold – and a continued downward trade on the dollar.