Back on a blog post October 11, 2011 - I explained divergence to be a condition that occurs when two lines on a chart move in opposite directions vertically. A technician will traditionally look for divergence between a stock's direction relative to the direction of a technical study such as a price oscillator or the MACD.
Divergence can also be observed when doing inter-market studies such as gold vs. the gold stocks, a large cap index vs. a small cap index or price vs. volume. There are two kinds of divergences: positive and negative which can be also described as a bull or bear setup
Our chart today is the daily closes – last Friday - of crude (WTI) plotted above the daily closes of the US dollar index as replicated by the PowerShares ETF (UUP). The technical assumption here is that the two have an inverse relationship. So, when the UUP prints a new trading high at (B) relative to the old high at (A) - we expect the crude price to print a new low at (B) relative to the old low at (A). Clearly this did not occur – note the higher crude low at (B) which is a positive divergence condition creating a bull setup signal for WTI crude. Keep in mind this is a daily or short term signal and short term trend reversal studies can generate false signals.