Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ====== Bearish Divergence ====== Bearish Divergence is a signal used in [[technical analysis]] that can flash a warning sign about a stock's seemingly unstoppable climb. Imagine a car speeding up a hill. You see it reach a new, higher point on the road, but at the same time, you hear the engine sputtering and losing power. That's the essence of a bearish divergence. The stock's price is making new highs, but the momentum indicator—a tool that measures the speed and strength of price movements, like an [[oscillator]]—is failing to do the same. Instead, the indicator is making lower highs. This "divergence" between price and momentum suggests that the buying pressure is weakening. The rally might be running out of steam, and a potential price drop or reversal could be just around the corner. It's a classic case of the price chart saying one thing ("We're going to the moon!") while the underlying momentum whispers, ("I'm not so sure about that..."). ===== How Does It Work? ===== At its core, a bearish divergence signals a disconnect between price and momentum. In a healthy uptrend, both the price and the momentum indicator should be marching upward together, making higher highs in sync. When the price continues to rise but momentum starts to lag, it’s a red flag. It tells traders that despite the new price peak, the conviction behind the move is fading. The enthusiasm is waning, and fewer buyers are jumping in at these elevated prices. This signal is most often spotted using momentum indicators, which are displayed on a chart, typically below the price. The most popular tools for identifying divergence are: * The [[Relative Strength Index (RSI)]] * The [[Moving Average Convergence Divergence (MACD)]] * The [[Stochastic Oscillator]] ==== How to Spot It in 3 Simple Steps ==== Finding a bearish divergence is like being a detective looking for conflicting clues. Here’s a simple guide: - **Step 1: Find the Uptrend.** Look at a stock's price chart. You need to see a clear uptrend where the price makes a high, pulls back slightly, and then makes an even //higher// high. - **Step 2: Check the Indicator.** Now, look at your chosen momentum indicator (like the RSI) for the exact same period. Find the peaks on the indicator that correspond with the peaks in the price. Did the indicator also make a higher high? If it made a //lower// high, you have a potential divergence. - **Step 3: Connect the Dots.** Draw a line connecting the two highs on the price chart (this line will be sloping up). Then, draw a line connecting the corresponding highs on the indicator chart (this line will be sloping down). If the lines are moving in opposite directions, congratulations—you've spotted a bearish divergence. ===== Why Should a Value Investor Care? ===== Advocates of [[value investing]], like the legendary [[Warren Buffett]], typically scoff at chart patterns, focusing instead on a company's [[fundamental analysis]]—its earnings, debt, and management quality. So why should a value investor give a hoot about a technical signal like bearish divergence? Because it can be an incredibly useful //tool// in your toolkit, especially for timing decisions. Think of it as a smoke alarm. Your primary fire detection method is your own deep research into a company's [[intrinsic value]]. But if you've determined a stock you own has become overvalued and you're thinking of selling, a bearish divergence can be the alarm that says, "Now might be a good time to act." It provides an external data point suggesting that other market participants also feel the price has gotten ahead of itself. It can help you time your exit, allowing you to sell a fundamentally overvalued stock before a significant price correction occurs. It’s not a reason to sell on its own, but it’s a powerful confirmation signal when aligned with your fundamental research. ===== The Pitfalls: Not a Crystal Ball ===== It's crucial to remember that a bearish divergence is an //indicator//, not an oracle. It signals a high //probability// of a reversal, not a certainty. Relying on it blindly is a recipe for trouble. Here are the key limitations: * **[[False Signals]] are Common:** A divergence can appear, and the stock can simply shrug it off and continue climbing for weeks or even months. Momentum can wane, then pick right back up. * **Timing is Tricky:** Divergence tells you that a reversal //might// happen, but it doesn't tell you //when//. Acting too soon could mean you miss out on further gains. * **It Requires Confirmation:** Never act on divergence alone. Smart investors wait for additional confirmation, such as the price breaking below a key [[trendline]] or support level, before making a move. For a value investor, the key is perspective. Use bearish divergence not as a primary decision-driver, but as a secondary piece of evidence to support your fundamental thesis about a company's valuation.