Niche theory predicts that different species are specialized for different niches, functionally divergent, and therefore coexist. It is however debated whether the functional trait differences across species actually result in functional divergence and niche separation. We integrated biophysical principles in a plant model to understand how functional plant traits affect growth, survival and niche separation along gradients of light and water availability for saplings of 13 co-existing tropical dry forest tree species. Simulations show that functional traits result in a plant strategy spectrum, varying from acquisitive species with high growth rates at saturating resource levels to conservative species with high tolerances for both shade and drought. Conservative species thus survive within a larger fundamental niche. Most species grow more rapidly than other competing species at certain combinations of resource levels, and occupy therefore a unique realized niche. Our simulations predict functional divergence across species to both light and water availability gradients. Intriguingly, for the investigated dry tropical forest, the functional divergence only resulted in light niche separation across species.