Divergence is not a magic out of no-where, it is a pattern of price action.
1. When will a divergence occur?
There is a regular divergence for a drift with trend;
There is a reverse divergence for a drift against trend;
and even more:
<b>Any</b> regular divergence must be a drift with trend if a suitable higher time frame is used.
<b>Most</b> reverse divergences are drifts against trend if a suitable higher time frame is used.
2. What is the consequence of divergence?
When a drift is with the trend, the trend will likely reverse;
When a drift is against the trend, the trend will likely resume;
so
A regular divergence means the trend likely to reverse (<b>but be aware of the degree</b>);
A reverse divergence means the trend likely to resume;
3. What is drift?
Drift is a pattern for which price is restricted in a slightly-slanted channel with non-increasing pivot distances. Drift can a flag, pennant, wedge and triangle.
4. Why so much divergence?
For 30% time, market is in trend mode;
For 70% time, market is in trading mode;
So
For 30% time, market is in impulse move;
For 70% time, market is in drift move;
So
For 30% time, market is likely to haveno divergence;
For 70% time, market is likely to have divergence (either regular or reverse divergence).
5. Any role of indicator here?
It would be better if one can identify divergence just from naked price chart. In fact, it is very easy.
Nearly all oscillating-type indicators are either the differences or normalized differences, thus very sensitive to the price change, and are good for spotting divergence.
Following this line, one can construct infinite indicators that are much sensitive to divegence by just taking higher order difference.
6. Why one indicator shows divergence but others not?
As just said in 5, nearly all indicators are detrended prices, but meanwhile they are filtered de-trended prices. Due to the filtering property, each indicator has a cut-off frequence range. Thus, different indicators have different sentivity to the price change.
For example, CCI is non-smoothed de-trended price, the high-frequent components of prices are kept, so it is very sensitive to the price change, while MACD(12, 26, 9) is a smoothed de-trended prices, so it is not sensitive to the change in high-frequent components. So it maybe the case that there is a divergence in CCI, but not in MACD.
7. Why divergence appear on so many time frame/for so many indicators/with so many different setting?
Market is a self-similar fractal: a feature exists in all scales.
8. How to use divergence in trading?
Use it as a warning sigh;
Use it with the trend.
