A bullish divergence is defined on a chart when prices make new lower lows but a technical indicator that is an oscillator doesn’t make a new low at the same time. This is a signal that bearish sentiment is losing momentum with the high probability that buyers are stepping in and the market may be near a bottom on the chart’s time frame. In many instances a bullish divergence can be the key indication on a chart that signals the end of a downtrend and that the risk/reward ratio has shifted in the favor of the bulls.

Technical oscillators include the popular Relative Strength Index (RSI) and Moving Average Convergence-Divergence (MACD). The RSI not only measures the extremes of overbought (70) or oversold (30) but can also show divergences between it making lower lows and price  not making lower lows. The MACD can not only signal bullish or bearish crosses but also its divergence with price action. 

The RSI or MACD can be used as one way to filter price action and momentum but they can also be used in comparison with price as you look at direction of the indicators momentum versus the trend in price action. The divergence between the technical indicator and the price movement can signal changes in a trend and the probabilities of a reversal. 

A bullish divergence is signaled when prices move lower but a technical indicator that is an oscillator moves higher. This is a valid technical signal to go long based on technical analysis. Of course it is just a high probability, it doesn’t always work so proper position sizing is still required and stop losses must be used. Also the profitability is not in the entry it is in the exit so it is crucial to have a strategy in place for how you will both maximize and eventually lock in profits when it does work out as a big win. 

bullish divergence

Chart courtesy of TrendSpider.com

By Steve Burns

After a lifelong fascination with financial markets, Steve began investing in 1993 and trading his accounts in 1995. It was love at first trade. After more than 30 successful years in the markets, Steve now dedicates his time to helping traders improve their psychology and profitability. New Trader U offers an extensive blog resource with more than 4,000 original articles, online courses, and best-selling books covering various topics.