Recently, while organizing my trading notes, I recalled a commonly overlooked indicator—the divergence rate. Honestly, many people know about this tool but don’t really know how to use it, and even treat it as a simple buy or sell signal, which often leads to significant losses. In fact, the core logic of the divergence rate is quite simple: it measures the gap between the price and the moving average.

Let’s start with the basics. The divergence rate essentially tells you how far the current price is from the average cost. When the price deviates too much from the moving average, the market is often in an extreme state, and the price will eventually revert to the mean—that’s why the divergence rate can help you find entry and exit points. The calculation is also straightforward: (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 indicates a premium (positive divergence), while a negative result indicates a discount (negative divergence).

But here’s a key point: divergence always exists because moving averages are lagging indicators. When prices move, the moving average is still averaging past prices, so its response speed can never match real-time prices. It’s precisely because of this characteristic that you can use the divergence rate to identify trading opportunities.

Regarding how to judge extreme values, there’s no absolute answer; it depends on the market type. For example, with a 15-day divergence rate, the S&P 500 is usually considered extreme at around 3 to 5%, Bitcoin at 8 to 10%, and gold roughly 2 to 5%. But these are just references; each asset is different, and you need to backtest to find reasonable extreme value ranges.

My personal favorite is combining the divergence rate with divergence signals. There are two types of divergence: one is top divergence, where the price hits a new high but the divergence rate doesn’t follow suit, indicating weakening momentum and a possible pullback; the other is bottom divergence, where the price hits a new low but the divergence rate doesn’t, which often signals a bottom reversal. Especially when bottom divergence occurs alongside extreme values, the win rate tends to be higher.

As for parameter settings, software defaults are usually 6, 12, or 24 days, but in practice, I prefer to adjust them according to my trading style. Short-term traders might use 5 or 10-day moving averages to capture intraday fluctuations; swing traders might use 20-day moving averages to judge medium-term trends; long-term investors often look at 60-day moving averages to identify overbought or oversold zones on larger cycles.

In actual trading, my most common strategy is combining extreme values with candlestick reversals. When the divergence rate deviates significantly from extreme levels, although it’s impossible to precisely predict the reversal point, that area is often a historical low. Seeing a lower shadow (wick) at this time can allow for phased entries and cost averaging. Another approach is to look for bottom divergence in a long-term rising market: when the price drops below a previous low but the divergence rate doesn’t make a new low, it’s a good entry point.

But it’s important to emphasize that divergence rate should not be used alone. Its real purpose is as a warning signal, best combined with price action or other indicators (like RSI entering oversold territory) to maximize effectiveness. Moreover, in strong trending markets, divergence can become dulled; prices may stay significantly divergent for a long time without immediately reverting, or even consolidate sideways before a new upward wave begins.

So, the correct way to use the divergence rate for finding buy and sell points is: first, observe the asset’s historical trend to identify extreme levels, mark them on your indicator, and then confirm with other signals. Remember, indicators are just auxiliary tools; the trend is the main focus. Prices may fluctuate sharply in the short term due to emotional factors, but ultimately, they tend to revert to the mean—that’s the market truth the divergence rate aims to reveal.