Types of Divergences

Types of Divergences

Divergences, whether bullish or bearish in nature, have been classified according to their levels of strength. The strongest divergences are Class A divergences; exhibiting less strength are Class B divergences; and the weakest divergences are Class C. The best trading opportunities are indicated by Class A divergences, while Class B and C divergences represent choppy market action and should generally be ignored.

Class A bearish divergences occur when prices rise to a new high but the oscillator can only muster a high that is lower than exhibited on a previous rally. Class A bearish divergences often signal a sharp and significant reversal toward a downtrend. Class A bullish divergences occur when prices reach a new low but an oscillator reaches a higher bottom than it reached during its previous decline. Class A bullish divergences are often the best signals of an impending sharp rally.

Class B bearish divergences are illustrated by prices making a double top, with an oscillator tracing a lower second top. Class B bullish divergences occur when prices trace a double bottom, with an oscillator tracing a higher second bottom.

Class C bearish divergences occur when prices rise to a new high but an indicator stops at the very same level it reached during the previous rally. Class C bullish divergences occur when prices fall to a new low while the indicator traces a double bottom. Class C divergences are most indicative of market stagnation – bulls and bears are becoming neither stronger nor weaker.

Source: http://www.investopedia.com/articles/trading/04/012804.asp