Recently, while analyzing the market, I was reminded of the divergence rate indicator. To be honest, many traders have misconceptions about it, thinking that seeing extreme values means they should reverse their position, but in reality, they often get caught off guard. Today, let's talk about how to properly use this indicator.

The divergence rate is actually very simple; it's a tool to measure the difference between the current price and the moving average. When the price rises, the gap from the moving average widens, creating divergence. The formula is (closing price of the day minus the N-day moving average) divided by the N-day moving average, multiplied by 100%. A positive number indicates a premium, while a negative number indicates a discount.

But here’s a key point: how much divergence rate is considered reasonable? There’s no absolute answer; it depends entirely on market characteristics. I’ve compiled some common extreme value references: about 3-5% for the S&P 500, usually 8-10% for Bitcoin, and 2-5% for gold. However, these are just references; different assets can vary greatly, so it’s essential to backtest yourself before using the divergence rate.

Regarding setting the divergence rate, I recommend adjusting parameters based on your trading style. Short-term traders can use 5-day or 10-day moving averages to capture very short-term fluctuations. Swing traders might use the 20-day moving average to judge whether the medium-term trend is overheated. Long-term investors can look at the 60-day moving average to observe overbought or oversold zones on larger cycles. This approach to setting divergence rates will better match your trading rhythm.

In live trading, my most common strategy is combining divergence with candlestick reversals. When the divergence rate reaches an extreme value and is accompanied by a lower shadow or other reversal signals, you can consider entering gradually. Another technique is divergence itself: for example, if the price hits a new low but the divergence rate doesn’t, it’s often a sign of a bottom rebound.

But be cautious: in strong trending markets, divergence rates tend to become less effective. At such times, just looking at extreme values isn’t enough. I’ve seen situations where the divergence rate is large, but the price moves sideways for a long time. Therefore, it’s best to combine divergence with other indicators, such as RSI entering oversold zones, where the divergence rate is also at an extreme negative value. This dual confirmation is more reliable.

Ultimately, the divergence rate is just an auxiliary tool; the main focus should still be on the trend. The indicator can tell you that the price might revert to the mean, but in a strong unidirectional trend, the price can still experience significant deviations. So don’t rely solely on the divergence rate values; always consider the actual market conditions. Over the years, I’ve found that the biggest value of divergence rate is to alert you when the market might be entering an extreme state, signaling you to be cautious.