Normally stocks and their respective mathematical indicators confirm one another. For example, usually when a stock forms a lower low, so does one of it's mathematical indicators, and vise versa. However, sometimes a divergence takes place where the stockprice and the indicators do not match. Technical divergence can be thought of as an anommoly - in other words, the divergence can only sustain itself so long before the indicators and the stock price match again. Always be on the lookout for technical divergence as it can be a good warning that a stock is going to change direction.
Positive Divergence is a consition where a stock or security forms a lower low, but a mathematical indicator (such as the MACD, Stochastics, etc.) forms a higher low - hence, a divergence takes place. Traders should look for positive divergence when they are holding short positions as a signal to cover them. Positive Divergence is useful in that it often signals the end of a decline and /or buying opportunities well before the other more common chart patterns.
There are many stocks that formed positive divergence technical patterns in early to middle October 2002 that signaled a buying opportunity and was a warning to anyone holding shorts to cover their shorts and go long.
However, what really surprised me was that many newsletters and traders who use technical analysis totally ignored this bullish situation and continuted to either hold their shorts or short more as the market entered a huge rally. Basically, what happened was that the markets were in huge downtrends from late spring or most of 2002, and traders let themselves become biased to the short side as they ignored this positive divergence. Therefore, never allow yourself to become too bisaed on the short or long side that you become blind to the obvious. Becoming too biased either short or long can cloud your judgement. Remember to trade based on what the charts tell you, not your emotions!!!
Now it's time for some examples. Please note that I will be adding more examples as I find them.
WBSN was a nice example of a Positive Divergence. There are many stocks that formed positive divergence technical patterns in early to middle October 2002 that signaled a huge buying opportunity and was a warning to anyone holding shorts with huge gains to cover their shorts - WBSN is a nice example of one of them.
GMR above is an excellent example of Positive Divergence. Notice how the MACD indicator made a higher low while the stock price did not. Also notice the big price runup after resistance was cleared.
The Nasdaq formed a small Head and Shoulder pattern in early fall of 2002 and broke support by breaking the neckline of the pattern.
Afterwords, a nice downtrend ensued that rewarded traders who went short the tech stocks. However, after the fall, a positive divergence formed whereby the Nasdaq made a lower low, but the MACD made a higher low. This signaled the astute technical trader to exit his shorts.
The BPCOMPQ indicator is a VERY useful and accurate indicator (like the VIX) to signal market tops and bottoms. Typically, values under 30 signal oversold conditions while values in the high 40's to 50's signal maket tops.
This example shows Positive Divergence in the BPCOMPQ in October 2002 which also confirmed the divergence seen in many other stocks at the time. This positive divergence signaled the start of a powerful rally that started in early October and ended in late November.
Positive Divergence in the VIX was a clue that the VIX was going to rally and the market to tank.
MXIM is an interesting example, here you see both Negative and Postive Divergence. The Positive Divergence of course signaled the astute technical trader to exit short positions and go long.
Below is an example of how to use Positive Divergence in an intra day chart.