As investors, we often rely on technical indicators and market trends to guide our trading decisions. However, it is crucial to understand that markets can create diversions to hide real problems or issues. This article delves into the concepts of divergence and trade diversion, highlighting how they can be used to distract from underlying issues in the asset market.
Divergence: A Warning Sign or a False Alarm?
Divergence in technical analysis refers to a situation where the movement of an asset's price contradicts the indications provided by a technical indicator or other data. This discrepancy serves as a warning sign that the current price trend might be losing strength, potentially leading to a change in direction. There are two types of divergence: positive and negative. Positive divergence suggests a possible upward movement in the asset's price, while negative divergence indicates a potential downward movement.
While divergence can be a valuable tool in identifying potential reversals, it is essential to note that it should not be the sole basis for trading decisions. Divergence can persist for extended periods without resulting in a price reversal, and it does not accompany all significant price reversals. Traders must combine multiple indicators and analysis methods to validate a trend reversal before acting solely on divergence signals.
Trade Diversion: A Shift in Trade Patterns
Trade diversion is an economic term related to international economics in which trade is diverted from a more efficient exporter towards a less efficient one by the formation of a free trade agreement or customs union. This can lead to a shift in trade patterns, potentially causing a diversion from the real issues underlying the market trends.
Trade diversion can have both positive and negative effects. On the one hand, it can increase trade between unified states and create jobs. On the other hand, it can hurt non-member nations economically and politically, creating strained relationships between nations. The dynamics of trade diversion can be complex, and it is widely believed by economists that trade diversion is harmful to consumers.
Combining Price Action and Divergence
To effectively utilize divergence in trading decisions, it is crucial to integrate price action with discrepancy. Price serves as the ultimate indicator, and momentum indicators manipulate price data. Employing price action can aid decision-making when using the MACD. Fundamental guidelines for leveraging price action include:
- Expect to observe discrepancy on the MACD during slower price movements or sideways trends relative to prior price waves.
- Avoid exiting a trade solely based on discrepancy.
- Wait for the price to break the trend to confirm discrepancy before taking action.
Markets can create diversions to hide real problems or issues. Understanding the concepts of divergence and trade diversion is essential in navigating the complexities of the asset market. By combining multiple indicators and analysis methods, traders can make informed decisions and avoid being distracted by market trends. Remember, price action is the ultimate indicator, and momentum indicators should be used in conjunction with price action to validate trading decisions.