How to Spot Bearish and Bullish Divergence in Crypto: Trading Indicators

Indicators are essential tools in the world of trading, especially in financial and crypto markets, as they aid in making informed decisions. Traders use indicators to identify optimal points for taking profits and managing risk to minimize potential losses.

In cryptocurrency trading, two of the most commonly used and impactful indicators are bearish divergence and bullish divergence. This article delves into these two indicators, exploring what they mean, how they work, and why understanding them is crucial for successful trading decisions.

What Is Divergence?

Before going further into bearish and bullish divergence, it is important to understand what divergence is in the trading world.

Simply put, divergence means that there is a difference in direction between the price movement and a technical indicator, such as the Relative Strength Index (RSI) or other volume indicators. In trading, divergence usually indicates that the price may soon form a new trend or change direction. As such, divergence is often used as a confirmation signal to detect potential trend changes.

Divergence can be applied to different types of financial assets, ranging from gold, crypto, and stocks, to derivative contracts tied to physical assets such as oil and wheat. As such, it is a versatile analytical tool in the financial markets.

There are several types of divergence, including those that signal a potential price bullish or price bearish. Each type of divergence also has different levels of confirmation, ranging from strong to weaker, making it important for traders to understand each type before making a decision.

By understanding divergence, traders can be better prepared to capture profit opportunities or reduce the risk of loss amid dynamic market fluctuations.

Bullish Divergence

A bullish divergence is a technical pattern that appears when the price of an asset, such as a cryptocurrency or stock, begins to show signs of decreasing selling pressure after a period of significant decline or when the price is at a support level that is considered low. This situation indicates a potential price reversal to a higher direction.

Usually, bullish divergence is accompanied by indications of weakening selling volume, where pressure from sellers is reduced, as well as positive sentiment from news or fundamental factors that support a reversal. In technical analysis, bullish divergence patterns are often combined with other indicators, such as the Moving Average (MA) or Relative Strength Index (RSI), to strengthen the accuracy of the signals captured.

The presence of a bullish divergence provides traders with important information, namely a confirmation signal that the price trend may soon reverse, from a downtrend to an uptrend. With this confirmation, traders can predict the potential change in market direction, and this is useful for determining the right time to go long to maximize profit opportunities.

In addition, traders often combine bullish divergence analysis with other indicators, such as bullish candlestick patterns (e.g. hammer, morning star, or bullish engulfing), to strengthen price reversal signals. With these confirmations, bullish divergence becomes an important tool in trading strategies, especially in highly volatile markets such as crypto or other financial assets. Identifying this pattern helps traders gain more confidence when placing long positions, as the probability of a trend reversal towards higher prices increases.

Bearish Divergence

Bearish divergence is a pattern in technical analysis that often signals a possible trend reversal from upward to downward price movement. This pattern usually appears when an asset’s price approaches a resistance area or price ceiling, suggesting that buying pressure may be weakening and a potential downtrend is beginning to form.

A bearish divergence usually occurs when an asset’s price has experienced a significant increase but the momentum of the gain is starting to wane. Typically, this is often the result of the Fear of Missing Out (FOMO) phenomenon, where investors and traders enter the market out of fear of missing out on an opportunity for price gains. As a result, there is a surge in buying that causes prices to continue to rise significantly. However, behind the price increase, the strength of the momentum is actually starting to show signs of weakness

When this signal appears, especially at resistance levels or after a considerable upward movement, traders may consider Sell the Asset or Going Short in the Futures Market.

Divergence Pattern

Regular Divergence: Signal of Potential Trend Reversal

Regular divergence is a divergence pattern that indicates a possible trend reversal. They are very useful in identifying moments where an ongoing trend is likely to reverse, signaling traders to prepare for a change in strategy, especially when the price is at a significant support or resistance area.

Regular divergence is divided into two main types:

• Bullish Regular Divergence: This pattern indicates a potential change from a downtrend (bearish) to an uptrend (bullish). Bullish regular divergence occurs when the asset price forms a lower low while momentum indicators, such as RSI or MACD, form a higher low. This signals that selling pressure is starting to weaken, even though the price is still falling, so the potential for a reversal to the upside is greater.
• Bearish Regular Divergence: This pattern indicates a potential reversal from an uptrend (bullish) to a downtrend (bearish). Bearish regular divergence occurs when the asset price forms a higher high, but the momentum indicator registers a lower high. This indicates that buying momentum is weakening even though the price is still rising, and there is a possibility that the price will soon fall.

Regular divergence is often relied upon by traders who want to capitalize on opportunities from reversal movements. When this pattern appears, traders may consider starting to take positions opposite to the direction of the ongoing trend.

Hidden Divergence: Signal of Trend Continuation

Unlike the regular divergence which signals a reversal, the hidden divergence indicates a potential trend continuation. Hidden divergence is often used to confirm that the ongoing trend still has the strength to continue, thus helping traders maintain their positions within the ongoing trend.

Hidden divergence is also divided into two main types:

• Bullish Hidden Divergence: This pattern signals that the ongoing uptrend is likely to continue. Bullish hidden divergence occurs when the price forms a higher low, but the momentum indicator forms a lower low. This indicates that the market still has the strength to push prices higher, and the bullish trend is likely to continue.
• Bearish Hidden Divergence: This pattern indicates a possible continuation of the downtrend. Bearish hidden divergence occurs when the price records a lower high while the momentum indicator records a higher high. This situation indicates that selling pressure is still dominant, and the downtrend is likely to continue.

Hidden divergence is commonly used by traders who focus on trend following strategies. By identifying hidden divergence, traders can get confirmation that the ongoing trend has the potential to continue, allowing them to maintain their positions within the trend.

How to Use Divergence in Crypto Trading

Here step by step how as a trader can use Divergence in real trading situation :

1. Choose the Cryptocurrency to Trade, select a specific crypto asset you want to analyze and potentially trade.
2. Choose Key Technical Indicators, utilize technical indicators like the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), and Stochastic Oscillator to identify divergence.
3. Assess the Current Trend, examine the price chart to determine if the trend is currently moving upward (bullish) or downward (bearish).
4. Spot Divergence:
   • Bullish Divergence: Look for a lower low in price paired with a higher low on the chosen indicator, suggesting a potential upward reversal.
   • Bearish Divergence: Look for higher highs in price while the indicator shows lower highs, indicating a possible downward reversal.
   • Verify the Divergence, confirm the divergence by checking other technical indicators or chart patterns. The more signals you have that align, the stronger the indication of a potential trend shift.
   • Establish Entry and Exit Points, based on the divergence analysis, set precise entry and exit levels to execute your trades effectively.
   • Monitor Price Changes and Adjust, continuously watch price movements and make adjustments to the strategy as necessary. Move your stop-loss orders to secure profits or reduce potential losses as trends develop.

Following these steps can help you incorporate divergence effectively into your crypto trading strategy.

Example Of Divergence In Crypto Market

In the crypto market, a trader can find divergence in any pair on any timeframe. Here are some recent examples of divergence in the crypto market :

SUI/USDT (Bullish Divergence)

Bullish divergence formed. Where the SUI price forms a low and lower low on the chart, while the MACD forms a lower and lower high, indications like this we call bullish divergence.

And it was true that afterward the price rose from the level of $0.54 to $2.37, an increase of up to 3 fold.

STX/USDT (Bearish Divergence)

The Stacks coin on the daily timeframe was seen forming a Bearish Divergence when the coin rose Significantly in the first quarter of 2024. If calculated since the beginning of the bullish trend, Stacks managed to rise up to 10 times if calculated from the lowest level in 2023.

Of course, the bullish trend did not last forever, towards the 2nd quarter of 2024 it was seen that the price continued to fall. If a trader utilizes divergence, it is clear that the trader can take profit first and will not be dragged down by the bearish trend that occurs afterwards.

Read also: Top 5 Crypto Whale Tracker Tools to Monitor Market Movements in Real-Time

Conclusion

Divergence is a powerful analytical tool that can help traders identify potential trend changes, but it comes with its own challenges and risks. To use it effectively, traders should integrate divergence into a well-rounded trading strategy, understanding both its strengths and limitations.

For safer trading, it’s crucial to implement risk management tools like stop-loss orders and to diversify trading approaches, reducing the impact of market volatility and potential losses.