Hidden divergences

Hidden Divergences

Hidden divergences are a powerful, yet often overlooked, technical analysis technique used in trading to identify potential continuation patterns in a market trend. Unlike regular divergences, which signal potential trend reversals, hidden divergences suggest the existing trend is likely to continue. They are particularly useful when trading crypto futures due to the high volatility and frequent trend reversals common in these markets. This article will provide a comprehensive, beginner-friendly explanation of hidden divergences.

What are Divergences?

Before diving into hidden divergences, it’s essential to understand the broader concept of divergences. A divergence occurs when the price of an asset moves in the opposite direction of a technical indicator, such as the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), or Stochastic Oscillator. This disagreement between price and indicator suggests weakening momentum and potential changes in the prevailing trend.

• Regular Divergence: Indicates a potential trend reversal. For example, price making higher highs while the indicator makes lower highs (bearish divergence) or price making lower lows while the indicator makes higher lows (bullish divergence).
• Hidden Divergence: Signals a potential continuation of the current trend. This is what we will focus on.

Understanding Hidden Divergences

Hidden divergences occur when the price action confirms the strength of the existing trend, as indicated by the momentum indicators. They are more subtle than regular divergences and require a keen eye to spot.

There are two types of hidden divergences:

• Hidden Bullish Divergence: Occurs in an uptrend. The price makes a *higher low*, while the indicator makes a *lower low*. This suggests that while the price temporarily dipped, the underlying momentum remained strong, hinting at a continuation of the upward trend.
• Hidden Bearish Divergence: Occurs in a downtrend. The price makes a *lower high*, while the indicator makes a *higher high*. This indicates that the price temporarily rallied, but the momentum weakened, suggesting a continuation of the downward trend.

Identifying Hidden Divergences: A Step-by-Step Guide

1. Identify the Trend: First, clearly define the current trend. Is it an uptrend, a downtrend, or is the market in a consolidation phase? Hidden divergences are only relevant in trending markets. 2. Choose Your Indicator: Select a momentum indicator. Commonly used indicators include RSI, MACD, and Stochastic Oscillator. Fibonacci retracements can also be used in conjunction for confirmation. 3. Look for Price Action: Observe the price chart for higher lows (in an uptrend) or lower highs (in a downtrend). 4. Compare to the Indicator: Simultaneously, analyze the chosen indicator. Look for the opposite movement – lower lows (in an uptrend) or higher highs (in a downtrend). 5. Confirm the Divergence: If the price action and indicator movements align with the definition of a hidden bullish or bearish divergence, you’ve potentially identified a continuation signal. Confirm with support and resistance levels.

Example: Hidden Bullish Divergence

Let's say the price of Bitcoin is in an uptrend.

• The price makes a higher high at $30,000.
• The price then retraces and makes a higher low at $28,000.
• Simultaneously, RSI makes a lower low during the same retracement period.

This is a hidden bullish divergence. It suggests that despite the temporary pullback, the underlying momentum is still strong, and the price is likely to continue its upward trajectory. Consider using a breakout strategy after confirmation.

Example: Hidden Bearish Divergence

Let's say the price of Ethereum is in a downtrend.

• The price makes a lower high at $1,500.
• The price then rallies and makes a lower high at $1,600.
• Simultaneously, MACD makes a higher high during the same rally period.

This is a hidden bearish divergence. It suggests that despite the temporary rally, the underlying momentum is weakening, and the price is likely to continue its downward trend. This can be used with a scalping strategy.

Important Considerations and Limitations

• False Signals: Like all technical indicators, hidden divergences are not foolproof. False signals can occur, especially in choppy or sideways markets.
• Confirmation is Key: Always confirm hidden divergences with other technical analysis tools, such as trendlines, chart patterns (like flags and pennants), and volume analysis.
• Timeframe Matters: Hidden divergences are more reliable on higher timeframes (e.g., daily, weekly) than on lower timeframes (e.g., 1-minute, 5-minute).
• Volume Confirmation: Increasing volume during the continuation of the trend after a hidden divergence forms adds further confirmation to the signal. On-Balance Volume (OBV) can be useful here.
• Risk Management: Always use appropriate stop-loss orders to manage risk, even when trading based on seemingly strong signals like hidden divergences. Consider a trailing stop loss.
• Combining with other Strategies: Integrate hidden divergences into a broader trading strategy, such as position trading or swing trading.
• Don't rely solely on one indicator: Use a combination of indicators to corroborate the signal. Consider Ichimoku Cloud or Bollinger Bands.
• Beware of Market Manipulation: Be aware of potential market manipulation tactics that can create false signals.
• Understanding Liquidity is vital: Assess the liquidity of the asset before trading.
• Consider Order Flow analysis: Understanding the order flow can provide additional insight into market sentiment.
• Candlestick patterns can provide confirmation: Look for bullish or bearish candlestick patterns that align with the divergence.
• Utilize Moving Averages for trend confirmation: Ensure the price is above or below key moving averages.
• Learn about Elliott Wave Theory for context: Understanding wave patterns can provide a broader market context.
• Study Wyckoff Accumulation/Distribution for insight: Wyckoff’s methodology can offer valuable clues about market phases.

Conclusion

Hidden divergences are a valuable tool for identifying potential continuation patterns in trending markets. By understanding the principles behind them and combining them with other technical analysis techniques, traders can potentially improve their trading decisions and manage risk effectively, particularly in the dynamic world of cryptocurrency trading. Remember that no single indicator is perfect, and proper risk management is crucial for success.

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