diff --git a/mercurial/cmdutil.py b/mercurial/cmdutil.py
--- a/mercurial/cmdutil.py
+++ b/mercurial/cmdutil.py
@@ -1518,7 +1518,7 @@ def diffordiffstat(ui, repo, diffopts, n
         width = 80
         if not ui.plain():
             width = ui.termwidth()
-        chunks = patch.diff(repo, node1, node2, match, changes, diffopts,
+        chunks = patch.diff(repo, node1, node2, match, changes, opts=diffopts,
                             prefix=prefix, relroot=relroot,
                             hunksfilterfn=hunksfilterfn)
         for chunk, label in patch.diffstatui(util.iterlines(chunks),
@@ -1526,7 +1526,7 @@ def diffordiffstat(ui, repo, diffopts, n
             write(chunk, label=label)
     else:
         for chunk, label in patch.diffui(repo, node1, node2, match,
-                                         changes, diffopts, prefix=prefix,
+                                         changes, opts=diffopts, prefix=prefix,
                                          relroot=relroot,
                                          hunksfilterfn=hunksfilterfn):
             write(chunk, label=label)
diff --git a/mercurial/color.py b/mercurial/color.py
--- a/mercurial/color.py
+++ b/mercurial/color.py
@@ -87,12 +87,14 @@ except ImportError:
     'branches.inactive': 'none',
     'diff.changed': 'white',
     'diff.deleted': 'red',
+    'diff.deleted.highlight': 'red bold underline',
     'diff.diffline': 'bold',
     'diff.extended': 'cyan bold',
     'diff.file_a': 'red bold',
     'diff.file_b': 'green bold',
     'diff.hunk': 'magenta',
     'diff.inserted': 'green',
+    'diff.inserted.highlight': 'green bold underline',
     'diff.tab': '',
     'diff.trailingwhitespace': 'bold red_background',
     'changeset.public': '',
diff --git a/mercurial/configitems.py b/mercurial/configitems.py
--- a/mercurial/configitems.py
+++ b/mercurial/configitems.py
@@ -481,6 +481,9 @@ coreconfigitem('experimental', 'evolutio
 coreconfigitem('experimental', 'evolution.track-operation',
     default=True,
 )
+coreconfigitem('experimental', 'worddiff',
+    default=False,
+)
 coreconfigitem('experimental', 'maxdeltachainspan',
     default=-1,
 )
diff --git a/mercurial/mdiff.py b/mercurial/mdiff.py
--- a/mercurial/mdiff.py
+++ b/mercurial/mdiff.py
@@ -67,6 +67,7 @@ class diffopts(object):
         'ignoreblanklines': False,
         'upgrade': False,
         'showsimilarity': False,
+        'worddiff': False,
         }
 
     def __init__(self, **opts):
diff --git a/mercurial/patch.py b/mercurial/patch.py
--- a/mercurial/patch.py
+++ b/mercurial/patch.py
@@ -10,6 +10,7 @@ from __future__ import absolute_import, 
 
 import collections
 import copy
+import difflib
 import email
 import errno
 import hashlib
@@ -2252,6 +2253,7 @@ def difffeatureopts(ui, opts=None, untru
         'showfunc': get('show_function', 'showfunc'),
         'context': get('unified', getter=ui.config),
     }
+    buildopts['worddiff'] = ui.configbool('experimental', 'worddiff')
 
     if git:
         buildopts['git'] = get('git')
@@ -2463,6 +2465,9 @@ def diffhunks(repo, node1=None, node2=No
 
 def difflabel(func, *args, **kw):
     '''yields 2-tuples of (output, label) based on the output of func()'''
+    inlinecolor = False
+    if kw.get('opts'):
+        inlinecolor = kw['opts'].worddiff
     headprefixes = [('diff', 'diff.diffline'),
                     ('copy', 'diff.extended'),
                     ('rename', 'diff.extended'),
@@ -2479,6 +2484,9 @@ def difflabel(func, *args, **kw):
     head = False
     for chunk in func(*args, **kw):
         lines = chunk.split('\n')
+        matches = {}
+        if inlinecolor:
+            matches = _findmatches(lines)
         for i, line in enumerate(lines):
             if i != 0:
                 yield ('\n', '')
@@ -2506,7 +2514,14 @@ def difflabel(func, *args, **kw):
                             if '\t' == token[0]:
                                 yield (token, 'diff.tab')
                             else:
-                                yield (token, label)
+                                if i in matches:
+                                    for l, t in _inlinediff(
+                                                  lines[i].rstrip(),
+                                                  lines[matches[i]].rstrip(),
+                                                  label):
+                                        yield (t, l)
+                                else:
+                                    yield (token, label)
                     else:
                         yield (stripline, label)
                     break
@@ -2515,6 +2530,70 @@ def difflabel(func, *args, **kw):
             if line != stripline:
                 yield (line[len(stripline):], 'diff.trailingwhitespace')
 
+def _findmatches(slist):
+    '''Look for insertion matches to deletion and returns a dict of
+    correspondences.
+    '''
+    lastmatch = 0
+    matches = {}
+    for i, line in enumerate(slist):
+        if line == '':
+            continue
+        if line[0] == '-':
+            lastmatch = max(lastmatch, i)
+            newgroup = False
+            for j, newline in enumerate(slist[lastmatch + 1:]):
+                if newline == '':
+                    continue
+                if newline[0] == '-' and newgroup: # too far, no match
+                    break
+                if newline[0] == '+': # potential match
+                    newgroup = True
+                    sim = difflib.SequenceMatcher(None, line, newline).ratio()
+                    if sim > 0.7:
+                        lastmatch = lastmatch + 1 + j
+                        matches[i] = lastmatch
+                        matches[lastmatch] = i
+                        break
+    return matches
+
+def _inlinediff(s1, s2, operation):
+    '''Perform string diff to highlight specific changes.'''
+    operation_skip = '+?' if operation == 'diff.deleted' else '-?'
+    if operation == 'diff.deleted':
+        s2, s1 = s1, s2
+
+    buff = []
+    # we never want to higlight the leading +-
+    if operation == 'diff.deleted' and s2.startswith('-'):
+        label = operation
+        token = '-'
+        s2 = s2[1:]
+        s1 = s1[1:]
+    elif operation == 'diff.inserted' and s1.startswith('+'):
+        label = operation
+        token = '+'
+        s2 = s2[1:]
+        s1 = s1[1:]
+
+    s = difflib.ndiff(re.split(br'(\W)', s2), re.split(br'(\W)', s1))
+    for part in s:
+        if part[0] in operation_skip:
+            continue
+        l = operation + '.highlight'
+        if part[0] in ' ':
+            l = operation
+        if l == label: # contiguous token with same label
+            token += part[2:]
+            continue
+        else:
+            buff.append((label, token))
+            label = l
+            token = part[2:]
+    buff.append((label, token))
+
+    return buff
+
 def diffui(*args, **kw):
     '''like diff(), but yields 2-tuples of (output, label) for ui.write()'''
     return difflabel(diff, *args, **kw)
diff --git a/tests/test-diff-color.t b/tests/test-diff-color.t
--- a/tests/test-diff-color.t
+++ b/tests/test-diff-color.t
@@ -259,3 +259,95 @@ test tabs
   \x1b[0;32m+\x1b[0m\x1b[0;1;35m	\x1b[0m\x1b[0;32mall\x1b[0m\x1b[0;1;35m		\x1b[0m\x1b[0;32mtabs\x1b[0m\x1b[0;1;41m	\x1b[0m (esc)
 
   $ cd ..
+
+test inline color diff
+
+  $ hg init inline
+  $ cd inline
+  $ cat > file1 << EOF
+  > this is the first line
+  > this is the second line
+  >     third line starts with space
+  > + starts with a plus sign
+  > 
+  > this line won't change
+  > 
+  > two lines are going to
+  > be changed into three!
+  > 
+  > three of those lines will
+  > collapse onto one
+  > (to see if it works)
+  > EOF
+  $ hg add file1
+  $ hg ci -m 'commit'
+  $ cat > file1 << EOF
+  > that is the first paragraph
+  >     this is the second line
+  > third line starts with space
+  > - starts with a minus sign
+  > 
+  > this line won't change
+  > 
+  > two lines are going to
+  > (entirely magically,
+  >  assuming this works)
+  > be changed into four!
+  > 
+  > three of those lines have
+  > collapsed onto one
+  > EOF
+  $ hg diff --config experimental.worddiff=False --color=debug
+  [diff.diffline|diff --git a/file1 b/file1]
+  [diff.file_a|--- a/file1]
+  [diff.file_b|+++ b/file1]
+  [diff.hunk|@@ -1,13 +1,14 @@]
+  [diff.deleted|-this is the first line]
+  [diff.deleted|-this is the second line]
+  [diff.deleted|-    third line starts with space]
+  [diff.deleted|-+ starts with a plus sign]
+  [diff.inserted|+that is the first paragraph]
+  [diff.inserted|+    this is the second line]
+  [diff.inserted|+third line starts with space]
+  [diff.inserted|+- starts with a minus sign]
+   
+   this line won't change
+   
+   two lines are going to
+  [diff.deleted|-be changed into three!]
+  [diff.inserted|+(entirely magically,]
+  [diff.inserted|+ assuming this works)]
+  [diff.inserted|+be changed into four!]
+   
+  [diff.deleted|-three of those lines will]
+  [diff.deleted|-collapse onto one]
+  [diff.deleted|-(to see if it works)]
+  [diff.inserted|+three of those lines have]
+  [diff.inserted|+collapsed onto one]
+  $ hg diff --config experimental.worddiff=True --color=debug
+  [diff.diffline|diff --git a/file1 b/file1]
+  [diff.file_a|--- a/file1]
+  [diff.file_b|+++ b/file1]
+  [diff.hunk|@@ -1,13 +1,14 @@]
+  [diff.deleted|-this is the ][diff.deleted.highlight|first][diff.deleted| line]
+  [diff.deleted|-this is the second line]
+  [diff.deleted|-][diff.deleted.highlight|    ][diff.deleted|third line starts with space]
+  [diff.deleted|-][diff.deleted.highlight|+][diff.deleted| starts with a ][diff.deleted.highlight|plus][diff.deleted| sign]
+  [diff.inserted|+that is the first paragraph]
+  [diff.inserted|+][diff.inserted.highlight|    ][diff.inserted|this is the ][diff.inserted.highlight|second][diff.inserted| line]
+  [diff.inserted|+third line starts with space]
+  [diff.inserted|+][diff.inserted.highlight|-][diff.inserted| starts with a ][diff.inserted.highlight|minus][diff.inserted| sign]
+   
+   this line won't change
+   
+   two lines are going to
+  [diff.deleted|-be changed into ][diff.deleted.highlight|three][diff.deleted|!]
+  [diff.inserted|+(entirely magically,]
+  [diff.inserted|+ assuming this works)]
+  [diff.inserted|+be changed into ][diff.inserted.highlight|four][diff.inserted|!]
+   
+  [diff.deleted|-three of those lines ][diff.deleted.highlight|will]
+  [diff.deleted|-][diff.deleted.highlight|collapse][diff.deleted| onto one]
+  [diff.deleted|-(to see if it works)]
+  [diff.inserted|+three of those lines ][diff.inserted.highlight|have]
+  [diff.inserted|+][diff.inserted.highlight|collapsed][diff.inserted| onto one]