Recently, while organizing my trading notes, I realized that many people are still a bit confused about the divergence rate indicator. Actually, its concept isn't that complicated. In simple terms, the divergence rate is a tool used to see how far the price is from the moving average, and how to interpret the divergence rate is based on a core logic: the price will eventually return to the average cost.

Let's start with the most basic part. The moving average is the average price over a past period. When the price deviates too far from the moving average, the market is usually in an extreme state. The formula for divergence rate is (closing price of the day minus the N-day moving average) divided by the N-day moving average, then multiplied by 100%. A positive result is called positive divergence (premium), and a negative result is negative divergence (discount).

How do we interpret this indicator? The zero line is the dividing point. When the divergence rate equals zero, the price is exactly aligned with the moving average. A value greater than zero indicates a strong market, while less than zero indicates weakness. But here’s a key point: positive divergence doesn't necessarily mean the price will fall, and negative divergence doesn't necessarily mean it will rise. The crucial factor is the degree of divergence. Moderate positive divergence indicates the bulls are in control, but extreme positive divergence suggests overbought conditions; moderate negative divergence indicates the bears are in control, but extreme negative divergence often signals oversold conditions, which could lead to a rebound.

So, what counts as an extreme value? There’s no standard answer; it depends on market characteristics. For example, with the 15-day divergence rate, the S&P 500 typically considers ±3% to 5% as extreme. Bitcoin, due to its high volatility, usually considers 8% to 10% as extreme. But the key is to backtest yourself because the extreme values for Bitcoin and Ethereum are different, so you must test for the specific asset you're trading.

How do I interpret divergence rate in actual trading? I usually combine it with candlestick reversals. When the divergence rate deviates significantly from extreme values and a lower shadow appears, it’s a good entry point for scaling in. There’s also an advanced technique called divergence, which is divided into top divergence and bottom divergence. Top divergence occurs when the price hits a new high but the divergence rate does not, indicating weakening momentum; bottom divergence occurs when the price hits a new low but the divergence rate does not, often signaling a bottom rebound.

Parameter settings are also very important. Short-term traders can use 5-day or 10-day moving averages to catch intraday fluctuations; swing traders use the 20-day moving average to judge medium-term trends; long-term investors use the 60-day moving average to observe overbought or oversold conditions over larger cycles. Software defaults are usually 6, 12, or 24 days, but in practice, it’s better to adjust according to the commonly used moving average parameters for the market you're trading.

Finally, a very important reminder: never rely solely on divergence rate for decision-making. Its essence is to tell you when the price deviates too far from the mean and might revert. But in a strong trend, the price can continue to deviate. So, the most accurate way to interpret divergence rate is to treat it as a warning signal, used together with other indicators or price action. For example, when RSI enters oversold territory and the divergence rate is also at an extreme negative value, then consider positioning for a long-term spot. Indicators are just tools; the trend is the main focus. Remember this, and you won’t be fooled by indicators.