In the field of economics and finance, there are a plethora of trends and tools to choose from. Divergence and convergence are two terms used to depict opposing forces. When two things diverge, it suggests that they travel in opposite directions, but when two things converge, it implies that they are moving in concert. Divergence vs. Convergence What's the Difference? There are two types of divergence and convergence in economics, finance, and trading: divergent and converging. Both phrases, however, pertain to how these interactions move, as implied by their meanings. In contrast to divergence, convergence shows how two trends move closer together.
Divergence
Whenever the value of one asset, indicator, or index shifts, the value of the asset, indicator, or even index connected to it shifts oppositely. What we see here is known as divergence. For example, a divergence may indicate that the present price trend is deteriorating and might even change direction.
Positive or negative divergence is possible. When a stock reaches a bottom, but its indications begin to rise, this is known as positive divergence. This might hint at a turnaround in the market's direction, which could provide a trading opportunity. A negative divergence occurs when prices rise while the indicator indicates a new low.
That doesn't indicate that the price will revert or reverse quickly when divergence is present. So responding only based on divergence might result in significant losses should the price not react as predicted. Divergence isn't the only thing traders look for while making trades. This is because it doesn't generate timely trading signals on its own.
Convergence
The concept of convergence may be thought of as the antonym of divergence. Over time, the futures and cash prices of an underlying commodity tend to move closer. The price movement of a futures contract is often described by traders using the term "convergence."
Since an efficient market will not enable a product to be traded at two different prices simultaneously, convergence occurs. Futures contracts are worth less than their issue price because traders must account for time value. The premium mostly on time value will decrease as the date of the contract's expiry draws closer, which will result in the two values coming closer together.
To benefit from a price discrepancy, traders would reap the benefits of a lack of convergence in the market. This would go on until there was convergence in pricing. Arbitrage is possible when prices do not converge. Arbitrage occurs when the same item is purchased and sold in various markets simultaneously, taking advantage of a price discrepancy. The market's inefficiencies are exploited in this circumstance.
Key Differences
Convergence is less of a worry to technical traders as they believe that in a healthy market, there will be divergence. Divergence is a popular tool for many technical indicators, mainly oscillators. The bands (lower and higher ones) are mapped out between two extreme values. Based on this information, they create trend indicators.
It is usual to perceive a trend's divergence as a sign of waning strength or the possibility of its unraveling. Divergence is a method traders who include technical analysis into their trading techniques used to "read" the fundamental momentum of the asset they are trading.
For technical analysis purposes, convergence occurs when an asset's price moves in the same direction as that of an indicator or index with which it is associated. Convergence occurs when the DJIA rises as its accumulation/distribution line rises.
How Can You Tell If the Trend Is One of Convergence or Divergence?
You must converge your series if your benchmark series is smaller than yours. In other words, your series converges or diverges depending on the benchmark. Additionally, if your series is more significant than a diverging benchmark series, then your series must diverge as well.
Conclusion
When two things diverge, it suggests that they travel in opposite directions, but when two things converge, it implies that they are moving in concert. In contrast to divergence, convergence shows how two trends move closer together. Convergence or divergence may be found in an endless series of numbers. A convergent sequence becomes an actual number at some point. It's impossible to stop a diverging sequence. As a result, this series leads to a value of 0.
