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Bullish Divergence

A bullish divergence between the price and a technical indicator is a moderately useful tool for detecting a coming reversal in the bearish trend. Bullish divergence in gold is therefore a moderately useful buy signal for the gold market.

Eric asks:

Eric and John are about to watch a game of football.

John, the Trader

John, the Trader

I just hate these commercials.
Eric, the Beginner

Eric, the Beginner

Yeah, me too. Let’s not waste time then.
John, the Trader

John, the Trader

What do you mean?
Read the whole discussion

The advantage of using bullish divergences is that it’s usually clearly visible, while the downside is that it doesn’t provide a precise buy signal. The divergence occurs when the price of an asset is somehow not in tune with what it is supposed to. For instance – when gold is declining but silver and/or mining stocks start to move higher – we see a bullish divergence.

The most common divergences are between asset’s price and some indicator based on it. In this case, the divergence occurs when price forms a lower low and the indicator forms a higher low. It shows us that even though price reaches new lows, the fuel for the downtrend starts running low. Divergence can show up on virtually any indicator’s chart, but the rule is always the same: the indicator does not confirm the price move. The charts below contain examples of bullish divergences.

Bullish Divergence in Gold

The chart below shows an example of bullish divergence on the gold market. It also illustrates one crucial idea when it comes to divergences: they do not necessarily show up on every indicator’s chart.

Bullish Divergence in Gold

The low from the second week of September on the RSI chart was on the same level as the one from the second week of August, while the corresponding lows on the charts of MACD and Stochastic Oscillator were considerably higher.

Bullish Divergence in Silver

The next chart presents an example of bullish divergence on the silver market:

Bullish Divergence in Silver

The consecutive lows on the silver chart in November and December were lower and lower, while the corresponding troughs on the Stochastic Oscillator’s chart were higher and higher.

Another important thing to remember here is that a bullish divergence should be confirmed in order to be treated as a bona fide buy signal. The confirmation can take place either on the price chart (breaking a previous resistance line) or the indicator chart (crossing an oversold line or centerline from below in case of oscillators such as RSI or Stochastic; crossing the signal line by the indicator line from below as in case of MACD, for instance) – or both.

Summary

A bullish divergence is an important and quite common notion in technical analysis and it is a very universal phenomenon (i.e. it can be seen on the charts of virtually all technical indicators) and yields a moderately reliable buy signal – the plus is that it’s seen quite often and is not too complicated; the downside is there is no clear buy signal. Consequently, we suggest using divergences along with other tools that provide such signals.

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