Divergence

What if there was a low risk way to sell near the top or buy near the bottom of a trend?
What if you were already in a long position and you could know ahead of time the perfect
place to exit instead of watching all your unrealized gains vanish before your eyes because
your trade reverses direction? What if you believe a currency pair will continue to fall but would like to go short at a better price or a less risky entry? Well there is a way. It’s called divergence trading. These part of the course will discuss all about the divergence trading and us all the what if questions we asked just now.

Divergence trading

What is divergence?

Charts always have a story to tell. However, from time to time those charts may be speaking a language you do not understand and you may need some help from an interpreter. Technical indicators are the interpreters of the forex market. They look at price information and translate it into simple, easy-to-read signals that can help you determine when to buy and when to sell a currency pair.Technical indicators are based on mathematical equations that produce a value that is then plotted on your chart. For example, a moving average calculates the average price of a currency pair in the past and plots a point on your chart. As your currency chart moves forward, the moving average plots new points based on the updated price information it has.Ultimately, the moving average gives you a smooth indication of which direction the currency pair is moving.Each technical indicator provides unique information. You will find you will naturally gravitate toward specific technical indicators based on your trading personality. In these part of the course we are going to be using specific indicators called oscillators to fully illustrate how divergence work. Traders and analysts of financial instruments, apart from the fundamentals, use a number of indicators to figure out what might happen to the price of a certain instrument. These indicators offer a simple method of recognizing patterns and predicting which way the price will trend. The use of these indicators is what makes forex signals possible, as they allow for real-time analysis of the price action. 

Since we are dealing with divergence, lets now see how these indicators will help us, divergence is basically price action measured in relationship to an oscillator indicator. It doesn't really matter what type of oscillator you use. You can use RSI, Stochastic, MACD, CCI, etc. etc. The great thing about divergences is that you can use them as a leading indicator and after some practice, it’s not too difficult to spot, when traded properly, you can be consistently profitable with divergences. The best thing about divergences is that since you’re usually buying near the bottom or selling near the top, your risk on your trades are very small relative to your potential reward.


What are type of technical indicators are used to check for divergence?

  • Trend indicators
  • Momentum indicators
  • expect advisors indicators
  • Oscillators indicators

How to see Divergence

Higher Highs and Lower Lows

Just think “higher highs” and “lower lows”.

If price is making higher highs, the oscillator should also be making higher highs. If price is making lower lows, the oscillator should also be making lower lows.If they are NOT, that means price and the oscillator are diverging from each other. Hence the term, divergence.note that are several types of divergence according to many traders, but we are going to do most important type: 

1. Regular

2. Hidden

How do you see when divergence has occurred?

  • When indicators make higher highs while price is making higher highs
  • When price is making lower highs while trend indicators is making higher highs
  • when oscillators make lower lows while price is making higher highs
  • None of the above

Regular Divergence

Regular Divergence

A regular divergence is used as a possible sign for a trend reversal. If the price is making lower lows (LL), but the oscillator is making higher lows (HL), this is considered regular bullish divergence. If the price is making a higher high (HH), but the oscillator is lower high (LH), then you have regular bearish divergence. from the picture above as illustrated, the green lines shows price doing lower lows while the oscillators are doing higher lows, these is a clear sign of bullish divergence occurring. The red lines represent regular bearish divergence, as price make higher highs, the oscillators do lower lows.

Hidden Divergence

A hidden divergence is used as a possible sign for a trend continuation.If price is making a higher low (HL), but the oscillator is making a lower low (LL), this is considered hidden bullish divergence. If price is making a lower high (LH), but the oscillator is making a higher high (HH), then you have hidden bearish divergence. From the picture above, we can recognize hidden divergence. As price makes higher lows as marked by green lines, the oscillator is making lower lows. As price is making lower highs, the oscillator is making higher highs as shown by the red line signaling hidden bearish divergence.

What is the difference between regular and hidden divergence?

  • hidden divergence is when trend changes lows or highs
  • Regular divergence indicate continuation of the trend
  • Hidden divergence is when price is making higher lows while the oscillator is making lower lows

Using Divergence to trade

Here’s how you could trade divergences:

The picture below is a summary of how one can trade using both hidden and regular divergence. Please keep in mind that we use divergence as an indicator, not a signal to enter a trade. It wouldn't be smart to trade basely solely on divergences as too many false signals are given.It’s not 100% foolproof, but when used as a setup condition and combined with additional confirmation tools, your trades have a high probability of winning with relatively low risk. On the flip side, we think it is just as dangerous to trade against this indicator. If you're unsure about which direction to trade, chill out on the sidelines.