Bearish divergence occurs when a technical analysis indicator is suggesting that a price should be going down but the price of the stock, future, or currency pair is continuing to maintain its current uptrend.
Bullish divergence occurs when the indicator is indicating that price should be bottoming and heading higher, yet the actual price action is continuing downward.
These divergences might signal a trader to get out of a long or short position before profits erode. The following chart of the E-mini S&P 500 Index Future shows some of these divergences:
High #1 to High #2
Looking at the E-mini S&P 500 future, from High #1 to High #2, the futures contract made higher highs, which is usually viewed as bullish. However, the MACD moving average failed to make a new high. This bearish divergence acted as an early warning sign of things to come with the E-mini S&P 500 futures contract.
Low #1 to Low#2
In yet another bearish sign for the E-mini S&P 500 futures contract, the future made higher lows from Low #1 to Low #2, which again is usually considered positive. Nevertheless, the MACD technical indicator made a clear lower low from Low #1 to Low #2. This bearish divergence warned of the impending downturn of the S&P 500 future and the market as a whole.
Low #2 to Low #3
In addition to bearish and bullish divergences, the MACD might confirm price movement as well. The E-mini S&P 500 futures contract made a substantial lower low which was confirmed by the MACD when it made a lower low as well.
As seen throughout the MACD sections, the MACD is a versatile tool giving a trader possible buy and sell entries and giving warnings of potential price changes.
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