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Technical analysis Technical indicators

Divergence of Price and Popular Indicators. We Will Check This Signal

Елена Берсенева 16 march 2022 125 4

In trading, there are many technical indicators and methods of the analysis using which a trader can predict deals and promptly get profit. And one of such instruments is Divergence.

 

Divergence is translated from the English language means “discrepancy” and appears in the chart if there is a discrepancy between price indicators and a technical indicator.

 

Assessment rules for divergence are simple. To estimate divergence, two upward maximums are enough in the price chart, and two downward maximums in the indicator chart, or two downward minimums in the price chart, and two upward minimums in the indicator chart. 

 

It is believed that divergence predicts correction or reversal from the preceding trend. 


To estimate divergence, a plenty of Indicators are used in trading.

 

For the analysis, we take several popular indicators at once. 

Hypothesis
To conclusion

A trading signal formed by the divergence of price and indicator is a profitable signal of technical analysis.

К выводам

In our study, we examine the following well-spread indicators:


Technical indicator
Indicator parameters
Author of a system
Divergence
Money Flow Index (MFI)
Period: 14
Standard. At the divergence between the price and indicator (details are not indicated)
Relative Strength Index (RSI)
Period: 14
J. Welles Wilder
 
Divergences are formed if the price reaches a new maximum (minimum) which is not proved by a new maximum (minimum) in the RSI chart.  
Moving Average Convergence/Divergence (MACD)
Rapid EMA: 12; slow EMA: 26; SMA: 9. At closing prices.
The bullish divergence appears if the MACD reaches new maximums and the price is unable to reach them. The bearish divergence is formed when the indicator reaches new maximums and the price does not reach them.
Stochastic Oscillator
Periods: 5 and 3. slowdown: 3. Prices: low/high.
Prices form a number of new maximums and the Stochatic Oscillator is unable to rise above its preceding maximums, it is a buy signal. Buys are mirror.
Accumulation/Distribution
No adjustable parameters
Divergences between the indicator of Accumulation/Distribution and the paper price indicate coming changes in prices. In case of divergence, the price trend usually changes in the direction of the indicator movement. So, if the indicator grows and the paper price falls, a reversal of prices is expected.
Commodity Channel Index (CCI)
Period: 14. At closing prices.
Divergence forms when the price reaches a new maximum and the Commodity Channel Index is unable to rise above the preceding maximums. Price correction is usually followed by this conventional divergence.
DeMarker
Period: 14
Divergence forms when the price reaches a new maximum and the indicator is unable to rise above the preceding maximums. Price correction is usually followed by this conventional divergence.
Momentum
Period: 14
The author of this instrument is not known. The greatest popularizer of Momentum is considered to be the popular trader Martin J. Pring.
Divergence forms when the price reaches a new maximum and the indicator is unable to rise above the preceding maximums. Price correction is usually followed by this conventional divergence.
Williams' Percent Range
Period: 14
Divergence forms when the price reaches a new maximum and the indicator is unable to rise above preceding maximums. Price correction is usually followed by this conventional divergence.



There are two types of divergence: the bullish and bearish.

 

In the charts, the bullish and bearish divergences of the price and indicator look like in the following way:


The Method of Event Detection

We will estimate the event with the following way (on the example of the bullish divergence):



  • Indicator [B1] < the oversold zone (When the price is in the oversold zone, sellers start to fix profit of short positions and as the result the price for an asset starts to rise and bulls start to increase long positions buying the asset at reduced prices.)
  • Indicator [В1] < Indicator [B1-1] and
  • Indicator [В1] < Indicator [B1+1] and
  • Indicator [В2] < Indicator [B2-1] and
  • Indicator [В2] < Indicator [B2+1] and
  • Indicator [B1] > Indicator [B2];
  • Low [A] < Low [B]
  • Low [A] < Low [А-1]
  • Low [A] < Low [А+1]
  • Low [A] < Low [А-2]
  • Low [A] < Low [А+2]
  • Low [В] < Low [B-1]
  • Low [В] < Low [B+1]
  • Low [В] < Low [B-2]
  • Low [В] < Low [B+2]

 

The formation of the bullish divergence is described above. For the bearish divergence, the situation is the is mirrored.

 

We will test the considered signals against a large amount of historical data of various financial instruments and on the basis of two timeframes.

 

Now, we specify conditions of the opening and closing of a trading position.


The opening of a position:

When a signal is formed, a position opens at the opening of a new candlestick:

  • The bullish divergence: a buy signal;
  • The bearish divergence: a sell signal.

 

The closing of a position:

The lifetime of positions 5 or 10 (in the candlesticks) is set in all cases. 

Data used

There is a list of financial instruments and their timeframes against which we will carry out the test of trading signals:

  • 23 currency pairs (Forex);
  • 5 commodity futures (Commodities);
  • 2 stock indices (Indices);
  • 30 stocks (Stocks).


Timeframes used:

  • H1 (1 hour): the history for the period of 5 years,
  • D1 (1 day): the history for the period of 10 years.


The sample is 2 101 235 values for every indicator.

Since we have specified all conditions and set necessary parameters, we can start testing!

 


Analysis of the results

 

First, we will estimate the results with the sampling number.


For the H1 timeframe (1 hour):


Indicator
Market segment
Number of candlesticks
Number of events
MFI
Forex
994755
8762
Commodities
172240
1389
Indices
87600
711
Stocks
628011
6313
RSI
Forex
994755
7405
Commodities
172240
1099
Indices
87600
605
Stocks
628011
4855
Stochastic
Forex
994755
7903
Commodities
172240
1294
Indices
87600
681
Stocks
628011
5230
CCI
Forex
994755
14522
Commodities
172240
2096
Indices
87600
1174
Stocks
628011
10309
DeMarker
Forex
994755
9133
Commodities
172240
1471
Indices
87600
738
Stocks
628011
6125
WPR
Forex
994755
10002
Commodities
172240
1310
Indices
87600
737
Stocks
628011
6877
MACD
Forex
994755
9538
Commodities
172240
1681
Indices
87600
921
Stocks
628011
5931
AD
Forex
994755
15373
Commodities
172240
2477
Indices
87600
1465
Stocks
628011
11180
Momentum
Форекс
994755
8140
Commodities
172240
1274
Indices
87600
674
Stocks
628011
6294



For the D1 timeframe (1 day):


Indicator
Market segment
Number of candlesticks
Number of events
MFI
Forex
83950
851
Commodities
18250
208
Indices
7300
100
Stocks
109129
1186
RSI
Forex
83950
642
Commodities
18250
139
Indices
7300
90
Stocks
109129
877
Stochastic
Forex
83950
895
Commodities
18250
204
Indices
7300
109
Stocks
109129
1042
CCI
Forex
83950
1480
Commodities
18250
336
Indices
7300
136
Stocks
109129
1720
DeMarker
Forex
83950
939
Commodities
18250
215
Indices
7300
92
Stocks
109129
1127
WPR
Forex
83950
1083
Commodities
18250
254
Indices
7300
128
Stocks
109129
1344
MACD
Forex
83950
763
Commodities
18250
188
Indices
7300
95
Stocks
109129
1187
AD
Forex
83950
1139
Commodities
18250
274
Indices
7300
133
Stocks
109129
1948
Momentum
Forex
83950
964
Commodities
18250
234
Indices
7300
119
Stocks
109129
1186



The total number of candlesticks and events with the two timeframes together:


Indicator
Number of candlesticks
Number of events
MFI
2 101 235
19520
RSI
2 101 235
15712
Stochastic
2 101 235
17358
CCI
2 101 235
31773
DeMarker
2 101 235
19840
WPR
2 101 235
21735
MACD
2 101 235
20304
AD
2 101 235
33989
Momentum
2 101 235
18885



Then, we discover the Share of Divergences in the total number of initial candlesticks with the two timeframes together:


Market segment
MFI
RSI
Stochastic
CCI
DeMarker
WPR
MACD
AD
Momentum
Forex
0.9
0.7
0.8
1.5
0.9
1.0
1.0
1.5
0.8
Commodities
0.8
0.6
0.8
1.3
0.9
0.8
1.0
1.4
0.8
Indices
0.9
0.7
0.8
1.4
0.9
0.9
1.1
1.7
0.8
Stocks
1.0
0.8
0.9
1.6
1.0
1.1
1.0
1.8
1.0
Average
0.9
0.7
0.8
1.4
0.9
1.0
1.0
1.6
0.9


As the result of grouping, we can conclude that irrespective types of financial instruments distribution of the events under our consideration is almost the same for every indicator.

 


Now, we turn to the results of performance of trading signals obtained through the outputs of Divergences of price and Indicators.

 

We will assess the results with two criteria:

  • Momentum (m) reflects the average interest of quotes increments of financial instruments at the moment of the position fixation, in %. A positive value of the momentum indicates the profitability of a signal performance, a negative value indicates loss-making.
  • SPP, the share of profitable positions, %.



The Momentum in % and the Share of profitable positions in % on a term-to-term basis of the hold of positions and timeframes for every Indicator:


Indicator
Indicator
5 candlestick
10 candlestick
H1
D1
MFI
m
-0.013
0.027
-0.017
0.031
SPP
49.2
50.0
49.6
49.6
RSI
m
0.047
0.011
-0.011
0.069
SPP
49.8
48.5
49.0
49.4
Stochastic
m
0.045
0.032
-0.018
0.095
SPP
49.5
49.0
49.3
49.2
CCI
m
0.049
0.034
-0.008
0.091
SPP
49.7
48.9
49.4
49.3
DeMarker
m
0.045
0.109
-0.003
0.156
SPP
49.4
49.4
49.1
49.7
WPR
m
0.044
0.029
0.000
0.073
SPP
49.9
48.1
49.2
48.7
MACD
m
0.024
-0.045
-0.008
-0.013
SPP
50.2
49.1
49.2
50.1
AD
m
-0.003
-0.069
-0.029
-0.043
SPP
49.7
49.4
49.2
49.9
Momentum
m
0.059
0.056
0.009
0.105
SPP
50.0
50.0
49.6
50.4



The Momentum in % and the Share of profitable positions in % on a basis of market segments for every Indicator:


Indicator
Indicator
Forex
Commodities
Indices
Stocks
MFI
m
0.037
0.142
-0.098
-0.031
SPP
49.8
53.6
46.1
49.0
RSI
m
0.059
0.183
-0.082
-0.013
SPP
50.3
51.9
43.5
48.2
Stochastic
m
0.050
-0.331
0.068
0.089
SPP
50.2
48.0
45.7
49.0
CCI
m
0.042
-0.103
-0.144
0.077
SPP
50.8
49.6
40.7
48.7
DeMarker
m
0.096
0.181
0.235
0.034
SPP
50.6
50.8
50.6
48.3
WPR
m
-0.002
0.081
-0.001
0.061
SPP
49.4
50.5
46.6
48.6
MACD
m
0.087
0.054
-0.023
-0.095
SPP
51.7
51.0
43.7
48.2
AD
m
0.006
-0.072
0.024
-0.066
SPP
49.5
51.5
50.2
49.2
Momentum
m
0.098
0.377
-0.073
-0.019
SPP
51.5
53.1
46.0
48.6


We can identify some of the following peculiarities:

  • The position fixation at the 5th candlestick is more profitable/less loss-making for all the indicators excluding the MFI and DeMarker ones;
  • Trading signals over the daily timeframe are more profitable/less loss-making for all the indicators excluding the MACD and AD ones.

 


Let us examine the results on a term-to-term basis of the hold of positions and timeframes.

 

We take the following notations:

«H1 / 5», the position fixation at the 5thth candlestick over the 1-hour timeframe;

«H1 / 10», the position fixation at the 10th candlestick over the 1-hour timeframe;

«D1 / 5», the position fixation at the 5th candlestick over the 1-day timeframe;

«D1 / 10», the position fixation at the 10th candlestick over the 1-day timeframe;

m, momentum, %;

SPP, the share of profitable positions, %.

 


The Number of Divergences, the Momentum in %, and the Share of profitable positions on a term-to-term basis of the hold of positions, timeframes and market segments (MFI):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
6313
711
1389
8762
17175
Momentum
-0.062
-0.014
0.084
-0.002
-0.025
SPP
48.9
49.7
50.7
49.7
49.4
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
6311
711
1389
8761
17172
Momentum
-0.044
-0.005
0.139
0.003
-0.010
SPP
49.2
51.4
51.1
50.2
49.8
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
1186
100
208
851
2345
Momentum
-0.012
-0.227
-0.010
0.032
-0.002
SPP
49.0
42.7
52.4
48.7
49.0
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
1183
99
208
850
2340
Momentum
-0.008
-0.149
0.355
0.114
0.064
SPP
49.0
40.5
60.1
50.4
50.1



The Number of Divergences, the Momentum in %, and the Share of profitable positions on a term-to-term basis of the hold of positions, timeframes and market segments (RSI):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
4855
605
1099
7405
13964
Momentum
-0.028
-0.022
0.035
-0.006
-0.014
SPP
49.2
47.9
49.5
48.6
48.9
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
4854
605
1098
7403
13960
Momentum
-0.014
-0.029
-0.006
-0.001
-0.009
SPP
48.7
47.1
49.7
49.5
49.0
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
877
90
139
642
1748
Momentum
0.017
0.079
0.520
0.138
0.108
SPP
48.1
42.4
57.2
53.6
50.8
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
876
90
139
642
1747
Momentum
-0.026
-0.356
0.185
0.105
0.031
SPP
46.7
36.8
51.3
49.8
47.9



The Number of Divergences, the Momentum in %, and the Share of profitable positions on a term-to-term basis of the hold of positions, timeframes and market segments (Stochastic):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
5230
681
1294
7903
15108
Momentum
-0.003
-0.012
-0.069
-0.001
-0.008
SPP
48.9
52.0
50.3
50.0
49.5
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
5229
681
1294
7901
15105
Momentum
-0.028
-0.031
-0.125
-0.006
-0.028
SPP
48.6
49.2
49.8
49.5
49.1
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
1042
109
204
895
2250
Momentum
0.191
0.101
-0.513
0.107
0.097
SPP
48.8
44.0
44.9
51.8
49.5
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
1041
109
203
894
2247
Momentum
0.197
0.213
-0.615
0.098
0.092
SPP
49.6
37.6
47.0
49.6
49.0



The Number of Divergences, the Momentum in %, and the Share of profitable positions on a term-to-term basis of the hold of positions, timeframes and market segments (CCI):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
10309
1174
2096
14522
28101
Momentum
-0.017
-0.008
0.012
-0.001
-0.008
SPP
48.6
50.2
50.6
50.5
49.5
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
10305
1174
2096
14520
28095
Momentum
-0.005
-0.002
-0.063
-0.002
-0.009
SPP
48.3
50.0
49.8
50.5
49.3
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
1720
136
336
1480
3672
Momentum
0.159
-0.148
-0.078
0.097
0.105
SPP
49.4
35.1
50.7
51.8
50.0
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
1718
136
336
1479
3669
Momentum
0.172
-0.418
-0.283
0.073
0.076
SPP
48.6
27.7
47.4
50.5
48.5



The Number of Divergences, the Momentum in %, and the Share of profitable positions on a term-to-term basis of the hold of positions, timeframes and market segments (DeMarker):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
6125
738
1471
9133
17467
Momentum
-0.055
-0.013
0.026
0.002
-0.025
SPP
48.2
48.2
47.7
50.1
48.9
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
6123
738
1471
9132
17464
Momentum
0.031
-0.031
0.072
-0.001
0.020
SPP
49.0
48.4
49.4
50.0
49.4
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
1127
92
215
939
2373
Momentum
0.028
0.610
0.110
0.185
0.114
SPP
48.5
60.1
51.4
50.7
50.0
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
1125
92
215
937
2369
Momentum
0.133
0.373
0.517
0.197
0.198
SPP
47.3
45.9
54.7
51.5
49.5



The Number of Divergences, the Momentum in %, and the Share of profitable positions on a term-to-term basis of the hold of positions, timeframes and market segments (WPR):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
6877
737
1310
10002
18926
Momentum
0.004
0.005
0.061
-0.002
0.007
SPP
49.1
48.7
52.3
50.4
49.9
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
6874
737
1310
9999
18920
Momentum
-0.011
-0.007
0.007
-0.003
-0.006
SPP
48.1
50.7
48.7
49.0
48.6
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
1344
128
254
1083
2809
Momentum
0.109
0.010
0.155
0.038
0.082
SPP
49.5
46.2
51.2
50.5
49.9
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
1341
128
254
1082
2805
Momentum
0.142
-0.011
0.098
-0.039
0.064
SPP
47.6
40.7
49.7
47.6
47.5



The Number of Divergences, the Momentum in %, and the Share of profitable positions on a term-to-term basis of the hold of positions, timeframes and market segments (MACD):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
5931
921
1681
9538
18071
Momentum
-0.010
0.007
0.015
0.003
-0,002
SPP
48.6
48.5
50.9
49.5
49.1
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
5930
921
1681
9537
18069
Momentum
-0.033
-0.011
0.016
0.004
-0.014
SPP
49.2
44.1
48.8
50.0
49.3
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
1187
95
188
763
2233
Momentum
-0.037
0.004
0.162
0.144
0.050
SPP
48.3
43.2
52.2
55.4
51.2
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
1185
95
188
763
2231
Momentum
-0.301
-0.091
0.022
0.196
-0.077
SPP
46.7
38.8
52.3
51.9
48.9



The Number of Divergences, the Momentum in %, and the Share of profitable positions on a term-to-term basis of the hold of positions, timeframes and market segments (AD):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
11180
1465
2477
15373
30495
Momentum
-0.023
-0.024
-0.041
0.002
-0.015
SPP
49.0
47.4
49.2
49.5
49.2
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
11178
1465
2477
15371
30491
Momentum
-0.077
-0.034
-0.060
0.005
-0.042
SPP
48.6
47.2
49.1
50.0
49.1
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
1948
133
274
1139
3494
Momentum
-0.031
0.175
0.077
0.032
0.009
SPP
50.1
54.1
53.0
49.3
50.2
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
1943
133
273
1139
3488
Momentum
-0.135
-0.024
-0.263
-0.014
-0.096
SPP
48.8
52.1
54.6
49.4
49.6



The Number of Divergences, the Momentum in %, and the Share of profitable positions on a term-to-term basis of the hold of positions, timeframes and market segments (Momentum):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
6294
674
1274
8140
16382
Momentum
0.001
-0.001
0.171
0.001
0.015
SPP
48.6
51.5
50.6
50.2
49.5
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
6292
674
1274
8137
16377
Momentum
-0.032
-0.017
0.218
0.004
0.003
SPP
49.0
49.4
51.7
50.3
49.7
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
1186
119
234
964
2503
Momentum
-0.005
-0.001
0.529
0.157
0.102
SPP
48.5
47.1
53.2
53.0
50.5
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
1183
117
234
962
2496
Momentum
-0.041
-0.274
0.592
0.230
0.108
SPP
48.5
36.1
57.0
52.4
50.3



We conclude the obtained results using the following diagram:

The highest momentum of 0.198 % is shown by the signals of Divergence of price and the DeMarker indicator over the timeframe of 1 day with the position fixation at the 10th candlestick.

 

The lowest momentum of -0.096 % is indicated by the signals of Divergence of price and the AD indicator over the timeframe of 1 day with the position fixation at the 10th candlestick.

 

The momentum from the signals of Divergence of price and all Indicators under our consideration excluding DeMarker is low. We can refer to them as ineffective. 


The signal of Divergence of price and the DeMarket indicator, on the contrary, has proved itself as profitable.

Conclusion

So, trading signals generated by the Divergence of price and all indicators excluding DeMarker are ineffective.


A signal created on a basis of Divergence of price and the DeMarker indicator has proved itself profitable.



Influence of an event based on Divergence of price and the DeMarker indicator on the market has been identified.


Influence of events based on Divergence of price and indicators of Money Flow Index, MACD, Stochastic Oscillator, Accumulation/Distribution, Commodity Channel Index, Momentum, Williams' Percent Range on the market has not been identified.

Detailed results are shown in the Appendix:

XLSX (0.12 MB)Application to the article 'Divergence of price and popular indicators_Let's check the effectiveness of the signal'.xlsx

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