Using Divergence Rate to Precisely Identify Buy and Sell Points: From Basic Settings to Practical Applications

In the investment market, no one can completely predict price trends, but we can understand market participants’ psychological expectations through technical indicators. Moving Average Deviation Rate (BIAS) is such a practical tool that helps investors determine overbought and oversold conditions.

What is the Deviation Rate? Why is it important?

The deviation rate is an indicator that measures the extent to which the stock price deviates from its moving average line, expressed as a percentage indicating the position of the price relative to the trend line. Simply put, when the stock price is far from its average trend, the deviation rate warns investors: the price may face a correction.

The deviation rate is categorized into two situations:

• Positive deviation rate: The stock price is above the moving average line, indicating bullish enthusiasm
• Negative deviation rate: The stock price is below the moving average line, suggesting possible panic selling

The core logic of this indicator stems from the market principle of “extremes reverse.” When a commodity or asset price surges rapidly, investors anticipate a decline and choose to sell; and vice versa. For example, during a bumper harvest year with abundant rice supply, farmers rush to sell, fearing prices will fall—investors face the same psychological reaction with stocks.

Calculation principle of the deviation rate

Calculation formula: N-day BIAS = (Closing Price on Day N - N-day Moving Average Price) / N-day Moving Average Price × 100%

The key to understanding this formula is the moving average (MA). The moving average helps investors see the long-term trend by averaging prices over a period. Because it relies on average prices, the deviation rate has a lagging nature, which requires special attention in practical applications.

How to set deviation rate parameters?

The setting of deviation rate parameters directly affects the accuracy of trading signals. Here is a complete setting guide:

Step 1: Choose the moving average period

Different investment styles require different period settings:

• Short-term trading: 5-day, 6-day, 10-day, 12-day MA
• Mid-term investment: 20-day, 60-day MA
• Long-term holdings: 120-day, 240-day MA

Step 2: Determine the deviation rate parameters

Common parameters include 6-day, 12-day, 24-day BIAS, and a deviation rate setting of 15 is also a commonly used mid-term parameter in practice. The principles for choosing parameters are:

• Shorter periods (like 5-day BIAS) are more sensitive and easier to capture short-term reversals
• Longer periods (like 20-day BIAS) are more stable, reducing false signals

When selecting, consider:

• The activity level of the stock (high volatility stocks are suitable for shorter periods)
• Current market environment (bull vs bear market)
• Personal trading style (short-term trading vs long-term investing)

Practical application: how to use the deviation rate to find buy and sell points?

Setting thresholds is crucial

First, set two key values for the deviation rate:

• Positive threshold (buy alert line): typical value is 2%~3%, but should be adjusted according to market volatility
• Negative threshold (sell alert line): symmetrical to the positive threshold

For example, if the threshold is set at 3%, then when BIAS ≥ 3%, it signals overbought; when BIAS ≤ -3%, it signals oversold.

Trading signal judgment

• BIAS exceeding the positive parameter: indicates the stock price has risen excessively, investors should consider partial profit-taking or halting chasing gains
• BIAS below the negative parameter: indicates the stock is oversold, with a rebound opportunity, suitable for strategic buying

Multi-moving average analysis

Single moving average deviation signals can produce false signals; it is recommended to combine multiple moving averages:

• Observe the 5-day and 20-day deviation rates simultaneously to determine if short-term and mid-term trends are aligned
• When all moving averages’ deviation rates are overbought or oversold simultaneously, the signals are more reliable

Divergence phenomena are most critical

This is the most important part of applying the deviation rate:

• Top divergence: stock price hits new highs but deviation rate does not reach new highs → prepare for a top
• Bottom divergence: stock price hits new lows but deviation rate does not reach new lows → prepare for a rebound

Limitations of the deviation rate

Although the deviation rate is a useful tool, investors must recognize its limitations:

1. Limited effectiveness in sideways or choppy markets
When stocks fluctuate within a low range for a long time, the deviation rate may not provide clear signals due to the lack of a definite trend background.

2. Lagging signals due to delay
Since the deviation rate is based on historical average data, it may miss the optimal trading opportunities. Therefore, it is better used as an auxiliary indicator for buy signals rather than the sole basis for sell decisions.

3. Effectiveness varies with market capitalization
Large-cap stocks tend to perform steadily, making deviation rate judgments more accurate; small-cap stocks are more volatile, and relying solely on deviation rate carries higher risk.

Best practice recommendations

Combine multiple technical indicators
The deviation rate should be used together with other indicators to improve success rates:

• Deviation rate + Stochastic Oscillator (KD): more accurately capture rebound timing
• Deviation rate + Bollinger Bands (BOLL): suitable for oversold rebounds and buy signals

Adjust parameters flexibly
There is no absolute optimal parameter. Investors need to continuously optimize based on historical data and personal experience, balancing sensitivity and stability.

Apply flexibly based on stock characteristics
Stocks with stable performance tend to rebound quickly during declines because market confidence is strong; stocks with poor performance may continue to weaken even if oversold. The same deviation rate signal can have completely different implications across different stocks.

The deviation rate BIAS is a classic and practical technical analysis tool. With correct setting methods and flexible application thinking, it can significantly improve investment decision success rates. The road of investing is long; mastering the essence of each technical indicator enables you to stand undefeated amid market fluctuations.