Recently, I’ve been studying the divergence rate indicator and found that many people actually don’t quite understand its true purpose, especially those trying to use it to find buy and sell points. Simply put, the divergence rate is a tool to measure how far the price is from the moving average, with the core logic that prices will eventually revert to the average cost.

Let me start with a basic concept: calculating the divergence rate is quite simple. It’s (today’s closing price minus the N-day moving average) divided by the N-day moving average, then multiplied by 100%. A positive result indicates a premium, while a negative result indicates a discount. For example, a divergence rate of 3 means the price is 3% above the moving average. It sounds simple, but in actual trading, many people encounter pitfalls.

My experience is that the extreme values vary greatly across different markets. For the S&P 500, overbought or oversold conditions are usually around 3 to 5%, but Bitcoin might need to reach 8 to 10% to be considered truly extreme. Gold typically ranges between 2 to 5%. So, before using the divergence rate to find buy and sell points, it’s essential to backtest your target asset to identify reasonable extreme value ranges.

I recommend pairing the divergence rate with candlestick reversal signals. When the divergence rate has already deviated significantly from the extreme values and the market is continuously declining, although it’s impossible to precisely predict which candlestick will reverse, this area has historically been a low point. If a lower shadow appears at this time, consider entering gradually to average down your cost. Using the divergence rate in this way can give you more confidence in identifying buy and sell opportunities.

Another practical signal is bullish or bearish divergence. When the price hits a new low but the divergence rate does not, it usually indicates that selling pressure is waning and may be a sign of a rebound. I often use this in long-term rising markets like the S&P 500, and the success rate is quite good.

Parameter settings are also very important. Short-term traders might use 5-day or 10-day moving averages, swing traders might prefer 20-day, and long-term investors might use 60-day. There’s no absolute standard; adjust according to your trading cycle.

Finally, I want to remind you that the divergence rate is just an auxiliary tool. Don’t rely on it alone to find buy and sell points. In strong trending markets, prices can stay at extreme divergence levels for a long time, causing the indicator to become less effective. It’s best to combine it with RSI, price action, or other indicators. The trend is the main focus; the divergence rate just tells you when opportunities might be present. Remember, prices will eventually revert to the mean, but the timing might be longer than you expect.