Thomas N. Bulkowski’s successful investment activities allowed him to retire at age 36. He is an internationally known author and trader with almost 30 years of stock market experience and widely regarded as a leading expert on chart patterns. His four books, including the best selling Encyclopedia of Chart Patterns, have been translated into six languages. He may be reached at

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Bulkowski’s Divergence

Market

Industrials (^DJI):

Transports (^DJT):

Utilities (^DJU):

Nasdaq (^IXIC):

S&P 500 (^GSPC):

As of 09/02/2010

10,320.10 50.63 0.5%

4,342.03 58.62 1.4%

396.87 -0.49 -0.1%

2,200.01 23.17 1.1%

1,090.10 9.81 0.9%

YTD

-1.0%

5.9%

-0.3%

-3.0%

-2.2%

Tom’s Targets

10,475 by 09/15/2010

4,450 by 09/15/2010

400 by 09/15/2010

2,250 by 09/15/2010

1,100 by 09/15/2010

Mkt Overview: 08/29/2010

Test Portfolios and CPI

Indus. strength: -6.9%

Mutt Losers: 10.2%

Mutt Winners: 1.1%

Wilder RSI: 1.2%

CPI: on 08/27/2010

Divergence occurs when an indicator trends in one direction and price trends in another direction. Specifically, an indicator will make lower highs while price makes higher peaks, or the indicator will make higher valleys even as price tumbles to new lows.

Divergence is a reliable trading signal, but it’s not timely, meaning that price usually follows the direction of the indicator, but it make take months before it does.

Bearish divergence

Bullish divergence

Other Examples

Bearish Divergence

Bearish divergence.

Bearish divergence (see adjacent chart) occurs when price makes a higher high but the indicator forms lower highs. The two data streams diverge in direction. Price will eventually, usually, follow the indicator lower.

Identification Guidelines

Characteristic	Discussion
Price trend	Upward forming higher peaks.
Indicator trend	Lower peaks.
One month	I found that the best divergence signals in the RSI and CCI indicators are when the peaks are spaced less than 2 months apart – 1 month apart is best (daily charts only).
Trends	Draw a trendline along the price peaks and it should slope upward. A trendline drawn along the indicator peaks should trend downward. Don’t draw trendlines along the valleys when looking for bearish divergence.

Trading Tips

If the price trend is up, then look for divergence among the peaks, not the valleys. When you spot divergence, recognize that the price trend may change. This doesn’t mean an immediate sale, but you should be ready to flee.

Bullish Divergence

Bullish divergence shows

Bullish divergence (see adjacent chart) occurs when price makes a lower low but the indicator forms higher lows. The two data streams diverge in direction. Price will eventually, usually, follow the indicator higher.

Identification Guidelines

Characteristic	Discussion
Price trend	Downward forming lower valleys.
Indicator trend	Higher valleys.
One month	I found that the best divergence signals in the RSI and CCI indicators are when the valleys are spaced less than 2 months apart – 1 month apart is best (daily charts only).
Trends	Draw a trendline along the price valleys and the trendline should slope downward. A trendline drawn along the indicator valleys must slope upward. Don’t draw trendlines along the peaks looking for bullish divergence.

Trading Tips

If the price trend is down, then look for divergence among the valleys, not the peaks. When you spot divergence, recognize that the price trend may change. This doesn’t mean an immediate buy, but consider taking a position soon, especially if you receive other confirming signals.

Bulkowski’s Divergence

Bearish Divergence

Identification Guidelines

Trading Tips

Bullish Divergence

Identification Guidelines

Trading Tips

Other Examples

See Also