Divergence? What is really happening with buyers vs sellers? | Forex Factory

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Divergence? What is really happening with buyers vs sellers?

  • #1
  • First Post: Apr 26, 2011 4:52pm Apr 26, 2011 4:52pm
Ok so I was helping a friend learn some basic trading patterns i.e. divergences, and he asked me what does it mean between buyers and sellers and how that is portrayed in between the Price action(PA) and the tech indicators.

At that moment I didnt even know "what" really are divergences besides the obvious

I have a feeling im just over analyzing this thing but I feel as if there is a better explanation that I could offer that would give that AH-HA moment

Any takers? and please do not reiterate the definition of the pattern but logically explain to a newbie type what is actually happening between buyers and sellers and how that discrepancy is portrayed between PA and the techs
  • #2
  • Apr 26, 2011 5:19pm Apr 26, 2011 5:19pm
i could be wrong, but divergence is a measurement of how far price is expected to move before the majority decide that it has gone too far to reasonably move any further and so bull/bear momentum is expected to reverse.

i believe the simplest way to explain it is the following example :

if you had a room of 100 traders where 50 are buyers and 50 are sellers and the buyers are willing to chase the price upwards then as each buyer takes possession of what is for sale they then become a seller looking to offload for a profit at some higher price. if all 50 buyers have bought from all 50 sellers then the roles have now swapped and the original sellers are looking to buy again, and the original buyers are now looking to offload and sell for a profit.

but if the price has moved too high then the original sellers might think it's no good to re-buy at this high price so the bull momentum will slow/stop and the market will be all buyers looking to now sell, and sellers now looking to buy cheap. the momentum is now expected to become a bear momentum as the price falls as each new seller looks to offload at hopefully a profit and each seller is looking to hopefully buy at a discount.

the fact that someone must have bought at the very top and someone sold at the very bottom is one part of what creates a situation where someone literally must lose for other participants to win. usually it's more than just one person who loses as each trader analyzes if their position is going to reap profit or loss and they then close for either a profit or loss. also, some traders are holding positions longer or shorter than other participants... this intermingling of expectations and holding timeframes creates the the market up and down pulses that sometimes drift bullish and other times bearish, and everything in between.
Congratulations ScalaFX for coming out of the closet!
  • #3
  • Apr 26, 2011 5:55pm Apr 26, 2011 5:55pm
Doesn't divergence only exist because 'indicators' lag? Depending on the number of bars and/or smoothing used to make the average, different data will be used to make the average, and when a sudden change in price happens the 'indicator' will take a shorter / longer time to respond to it. Thus, divergence only means that price is moving against the average; The 'divergence' will show when price has been moving against the average for a prolonged amount of time, but has not moved against it far enough to change the average.

I had to read the Babypips description to be sure of the meaning; I find it quite sad that they make it out to be somehow telling of 'something suspicious happening'. If I had to say what was happening in the market I would say that traders were unsure / unwilling to trade and therefore liquidity was low. You'd react to that information on its own by not trading your self.

PS. I'm always worried that my explanations aren't clear enough. Let me know if once you've thought about each line you still don't understand.
Living the adventure in my head.
  • #4
  • Apr 26, 2011 6:13pm Apr 26, 2011 6:13pm
Divergence definition.
  • #5
  • Apr 26, 2011 7:17pm Apr 26, 2011 7:17pm
If you read the book "Come into my trading room" Dr. Alexander Elder offers a very good explanation of divergence.

To paraphrase, it is generally the difference between the large traders and the retail traders. The large trader are exiting positions and selling them to retail traders. This creates a momentary counter trend swing which is rapidly bought up by the smaller retail traders who quickly exhaust themselves as no further large traders are entering. The price spikes quickly but usually has very low volume and poops out. This then causes price to fall (or rise).

Any given indicator (MACD, RSI, Stochastic) lags behind the actual price and is slow to follow the sudden spike in prices. Thus creates a smaller extreme that the previous peak (or valley). Voila! Divergence. Price has created a greater extreme while the lagging indicator creates a smaller extreme.

This is when the large trader come back into the market but in the opposite direction...now scooping up the retailer's losing positions and pushing the market in the opposite direction.

For those of us smaller retail traders we can recognize this pattern and exploit it. Often times the divergence will precede a change in direction and "call the top" (or bottom). If you are trading with the current trend this signals a quick and full exit. If you are waiting for a counter trend trade, this signals an entry with a very small risk and large potential reward.

Hope this helps.
  • #6
  • Apr 26, 2011 8:26pm Apr 26, 2011 8:26pm
Quoting nubcake
i could be wrong, but divergence is a measurement of how far price is expected to move before the majority decide that it has gone too far to reasonably move any further and so bull/bear momentum is expected to reverse.

i believe the simplest way to explain it is the following example :

if you had a room of 100 traders where 50 are buyers and 50 are sellers and the buyers are willing to chase the price upwards then as each buyer takes possession of what is for sale they then become a seller looking to offload for a profit at some higher price....
Hey nub,

I have to admit your theory is well thought out, but it appears to only explain normal market dynamics of OB/OS level. However I did use your explanation to my friend to help build his foundation for S/R and OB/OS levels and what they mean. thanks for the idea

P.S I fully credited your explanation to my friend lol
  • #7
  • Apr 26, 2011 8:27pm Apr 26, 2011 8:27pm
Quoting SatchFan
Divergence definition.
Thanks for the attempt Satch but I was looking for a little more than the obvious technical interpretation
  • #8
  • Apr 26, 2011 8:29pm Apr 26, 2011 8:29pm
Quoting Leonlorenzo
Thus, divergence only means that price is moving against the average; The 'divergence' will show when price has been moving against the average for a prolonged amount of time, but has not moved against it far enough to change the average.
LL,

I think this sentence is a GREAT start to elaborate on, thanks
  • #9
  • Apr 26, 2011 8:35pm Apr 26, 2011 8:35pm
Quoting gspajon
If you read the book "Come into my trading room" Dr. Alexander Elder offers a very good explanation of divergence.

To paraphrase, it is generally the difference between the large traders and the retail traders. The large trader are exiting positions and selling them to retail traders. This creates a momentary counter trend swing which is rapidly bought up by the smaller retail traders who quickly exhaust themselves as no further large traders are entering. The price spikes quickly but usually has very low volume and poops out. This then...
I love DR. Elders books, I have all of them but failed to refer to my own library to find a laymens definition of the market psychology for divergences lol...kudos GSP for that
  • #10
  • Apr 26, 2011 8:43pm Apr 26, 2011 8:43pm
On a final note....

Has anyone primarily used this method to get in on trends OR countertrend fade trade OR use as a exit and TP?

Ive used this method as my primary PA analysis while utilizing candlesticks patterns like Bull/Bear engulfing candles, outside/inside candles and previous S/R for profit zones OR breakouts

I havent found a thread that primarily uses this method of divergence, if anyone knows please point the way!
  • #11
  • Apr 26, 2011 8:49pm Apr 26, 2011 8:49pm
Heads up!!!

In gbp/usd there is a bearish divergence on the 1hr TF with a lower high being made by bouncing off of a previous downward trendline and slow stoch being completely overbought!! Very clear signal I sold @1.6490
  • #12
  • Apr 26, 2011 9:07pm Apr 26, 2011 9:07pm
What a great question. I never thought to ask it and now trying to answer it, I'm a bit stumped... At the risk of sounding like an idiot, I'll give it a shot.

Lets take positive divergence using MACD, basically a moving average, moving higher while price is moving lower. If the average is on the close then this tells us that despite price moving lower the bars are starting to have higher closes. The higher closes mean that buyers are coming in and stating to accumulate in a down trend little by little and the momentum downward is slowing (less sellers entering), until such time as that the bulls over power the bears and price starts to move higher.

EDIT: If you notice the price action when you start to see divergence the chart gets very Zig-Zaggy (my term).

I guess my answer is that you have accumulation or distribution turning a trend (or more accurately near the ending / last part of the trend) vs. during consolidation.

Anyone that really knows this stuff, please feel to free to correct me if I have stated something incorrectly.
Don't wish it were easier, wish you were better. ~ Jim Rohn
  • #13
  • Apr 26, 2011 9:43pm Apr 26, 2011 9:43pm
Quoting bullish84
Thanks for the attempt Satch but I was looking for a little more than the obvious technical interpretation
How about this one.. it's not as obvious...
  • #14
  • Apr 26, 2011 9:45pm Apr 26, 2011 9:45pm
Quoting SatchFan
How about this one.. it's not as obvious...
thanks for the laugh
  • #15
  • Apr 26, 2011 9:52pm Apr 26, 2011 9:52pm
Quoting bullish84
thanks for the laugh
  • #16
  • Apr 26, 2011 9:52pm Apr 26, 2011 9:52pm
Quoting LasVahGoose
What a great question. I never thought to ask it and now trying to answer it, I'm a bit stumped... At the risk of sounding like an idiot, I'll give it a shot.

Lets take positive divergence using MACD, basically a moving average, moving higher while price is moving lower. If the average is on the close then this tells us that despite price moving lower the bars are starting to have higher closes. The higher closes mean that buyers are coming in and stating to accumulate in a down trend little by little and the momentum downward is slowing (less...
I have to say since my friend stumped me with this question, it really made me take a step back and re-learn something, and sometimes its alway good for us traders to take a step back and really identify what happens/ed

As for your theory, I believe there is no complete right or wrong answer but only HOW one inteprets it.
  • #17
  • Apr 26, 2011 10:22pm Apr 26, 2011 10:22pm
Quoting bullish84
On a final note....

Has anyone primarily used this method to get in on trends OR countertrend fade trade OR use as a exit and TP?...I havent found a thread that primarily uses this method of divergence, if anyone knows please point the way!
I use divergence as entry signals AND exit signals as well as a hard limit order for a first target. A technique that is extremely useful is this:

  1. Observe trend on daily chart (higher highs/higher lows etc)
  2. Wait for retrace in trend then use fibonacci to detect possible retrace points
  3. As price approaches a given fibo level switch to a lower time frame (1 hr or 15 min)
  4. Watch for divergence that will put you back into the direction of the trend
  5. Divergence on the smaller time frame will help you time the entry with as little as 15 pip stop


You can find a MACD divergence thread here: http://www.forexfactory.com/showthread.php?t=99876 However lately I've been the only contributor...its not really a "hot topic"

  • #18
  • Apr 27, 2011 7:09am Apr 27, 2011 7:09am
Quoting bullish84
Heads up!!!

In gbp/usd there is a bearish divergence on the 1hr TF with a lower high being made by bouncing off of a previous downward trendline and slow stoch being completely overbought!! Very clear signal I sold @1.6490
If any1 followed that signal through for the next few hours would've netted a decent spread, I moved my stop to break-even at the 6470 level and was limit out for a net 36pips. In total I netted a cool 1:1 R/R

Reason for the tight limits and stops was that I didn't want to stay in the trade too long before event risk (Gbp GDP ) would've had to had been adjusted for and I'm going to wait out the fomc news events today from 12-2:15pm
  • #19
  • Apr 27, 2011 7:32am Apr 27, 2011 7:32am
Quoting bullish84
Hey nub,

I have to admit your theory is well thought out, but it appears to only explain normal market dynamics of OB/OS level. However I did use your explanation to my friend to help build his foundation for S/R and OB/OS levels and what they mean. thanks for the idea

P.S I fully credited your explanation to my friend lol
yeah as soon as i saw the other replies i realised i had myself backwards and upside down. oops.

thanks for the credit btw... "yeah some nubcake told me this", lol
Congratulations ScalaFX for coming out of the closet!
  • #20
  • Apr 27, 2011 7:51am Apr 27, 2011 7:51am
Quoting nubcake
yeah as soon as i saw the other replies i realised i had myself backwards and upside down. oops.

thanks for the credit btw... "yeah some nubcake told me this", lol
no sweat...lol...yea I told him some "nub" gave me the idea !
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