Classic divergence is one of the best-known types of non-confirmation. A divergence is a separation between price and indicator that warns of a possible short- to intermediateterm change of trend.
A bullish divergence arises during a down move when price makes either a lower low or a double bottom but the indicator makes a higher low or a double bottom. A bearish divergence occurs during an up move when price makes either a higher high or a double top and the indicator makes a lower high or a double top. Classic divergences can occur at price tops or bottoms and also at price corrections.
The chart of PepsiCo [PEP] in Figure 1 shows both a bearish and a bullish divergence. The stock price rose from April to the end of May 1995. The oscillator made a top in early to mid-May at point A.
However, when price made a top in late May (point B), the oscillator made a second top at a lower level. This was a sign that price momentum was decreasing and warned of a potential change in trend either from up to down or sideways. The stock made a corrective decline going into July. At the price low in mid-July (point D), the oscillator made a second bottom, but at a higher level. This signaled that downside momentum had decreased and either a potential rally or sideways move could occur. The bullish divergence was confirmed as price resumed its up move.
A bullish divergence arises during a down move when price makes either a lower low or a double bottom but the indicator makes a higher low or a double bottom. A bearish divergence occurs during an up move when price makes either a higher high or a double top and the indicator makes a lower high or a double top. Classic divergences can occur at price tops or bottoms and also at price corrections.
The chart of PepsiCo [PEP] in Figure 1 shows both a bearish and a bullish divergence. The stock price rose from April to the end of May 1995. The oscillator made a top in early to mid-May at point A.
However, when price made a top in late May (point B), the oscillator made a second top at a lower level. This was a sign that price momentum was decreasing and warned of a potential change in trend either from up to down or sideways. The stock made a corrective decline going into July. At the price low in mid-July (point D), the oscillator made a second bottom, but at a higher level. This signaled that downside momentum had decreased and either a potential rally or sideways move could occur. The bullish divergence was confirmed as price resumed its up move.
