Would you like to learn how to trade professionally using divergence? Many traders quite successfully use the discrepancy between the MACD, stochastics, RSI and price indicators.
Divergence trading is critical to many of the profitable systems traders use.
What is divergence?
The difference in trading charts is that the price action is different from the readings of various indicators, for example, MACD, Stochastic, RSI, etc. The idea is that divergence shows a decrease in momentum, which is not yet reflected in the price, but which may be early indicator of a reversal.
The most accurate indicators of divergence are Forex technical indicators, such as:
The effective use of the divergence trading system may be one of the best tools for predicting the situation and achieving effective trading results.
Divergence may be one of the best indicators to predict how the market will behave in the coming periods, thereby providing the investor with the opportunity to make the best informed trading decisions. So, how is trading using divergence in the Forex?
Forex Divergence and Convergence Review
As we have already determined above, divergence is when the price of an asset and the readings of the indicators considered move in opposite directions.
To determine what divergence is, we use one example. Consider a situation where market prices are rising and the technical indicator is falling. In this case, the trader will face decreasing dynamics and, therefore, signs of a trend reversal. The price and the technical indicator diverge, and therefore the trader can choose a sale for maximum profit.
Convergence
But besides the discrepancy between price and indicator, called divergence, there is an opposite phenomenon of the market. This phenomenon, called convergence, implies, on the contrary, the convergence of the price and the readings of the selected indicator.
What is convergence? This is when the price of an asset and the readings of indicators converge and move in the same direction. Convergence is a powerful indicator for all traders. Convergence, as the name implies, is when two or more indicators or other analysis devices follow the same path.
What is convergence can be analyzed by example, let's assume a situation in which market prices and a technical indicator show an uptrend. In this case, traders are faced with a continuing impulse, and there is a high probability that the trend will continue. So, here the price and the technical indicator converge (i.e., they are going in the same direction), and the trader may refrain from selling, since the price is likely to rise.
There are some types of convergence that are most common in the Forex market.
- Convergence indicator with price action. This is the simplest of all convergences, but perhaps the most important for observation, since it can influence the subsequent or opposite strategy. The convergence of the indicator with the price action means that as prices reach a new level, the indicator also becomes new.
- Convergence of indicators. From time to time, the indicators will converge. This usually happens within a few days and is usually called simply “confirmation”, since one indicator confirms another.
- Time Frame Convergence. Too often, a good signal fails because the time frame is not taken into account. During one period of time, one trend may exceed another, since one incoming wave overflows another when the stream adheres.
Thus, the divergence and convergence of Forex, working as an instrument of a strategy, are focused on one tool.
These types of convergence are not only powerful confirmations of signals, but also excellent ways to search for deals. As soon as the trader begins to recognize them, he will be able to find them on any chart or time interval that he chooses.
When studying the system, it is necessary to identify and highlight the components of divergence.
- The upward change is a bullish divergence.
- Descending is a “bearish divergence”.
Regular divergence
The classic divergence (regular) in Forex trading is a situation where the price action reaches higher highs or lower lows, but the indicator used remains in the same state.
This is an important sign that the trend is nearing completion and a trend reversal is expected. Thus, the Forex divergence strategy is based on identifying such a probability of a trend change and subsequent analysis to identify where and with what intensity such a change can occur.
The classic “bearish” divergence is a situation in which an uptrend is observed with the simultaneous achievement of higher highs by the price action, which remains an unconfirmed oscillator.
In general, this situation illustrates a weak uptrend. Under these conditions, the oscillator can either advance to lower maximums, or reach double or triple peaks (most often this is true for indicators over a large time period). In this situation, the divergence strategy should be to prepare for the opening of a short position, since there is a signal of a possible downtrend.
The classic “bullish” divergence suggests that in a downtrend, the price action reaches lower lows, which is not confirmed by the indicator. In this case, the trader is faced with a weak downtrend.
The indicator can either go to higher lows, or reach a double or triple bottom (which is more common in indicators related to the range, such as RSI). In this case, the divergent strategy at Forex should consist in preparing for the opening of a long position, as there is a signal of a possible uptrend.
Unlike classical divergence, hidden exists when the oscillator reaches a higher or lower minimum, while the price action remains unchanged.
Latent divergence
Under these conditions, the market is too weak for a final reversal, and therefore there is a short-term correction. After this, the prevailing market trend resumes, and therefore the trend continues. The latent divergence on Forex can be either bearish or bullish.
Hidden “bearish” divergence is a divergence situation in trading, where the correction occurs during a downtrend, and the oscillator falls to a low level, while this does not happen with the price action, it remains in the reaction or consolidation phase. This indicates that the downtrend is still strong and will resume soon. In this case, you must either hold or open a short position.
Hidden “bullish” divergence is a trading divergence in trading, in which correction occurs during an uptrend, and the oscillator reaches a higher maximum, while the price action does not do this, remaining in the correction or consolidation phase. The signal here means that the uptrend is still strong, and it is likely to resume soon. In this situation, you need to either hold or open a long position.
Exaggerated divergence
A significant difference between exaggerated and classical (regular) divergence is that here the price movement pattern forms two peaks or bottoms, with corresponding maxima or minima located approximately on the same line. At the same time, the technical indicator shows the corresponding tops or bottoms in a clearly visible upward or downward direction.
Exaggerated “bearish” divergence is a situation where the price forms two peaks on approximately the same line (with some really small deviations), while the technical indicator diverges and has a second upper position at a lower level. In this situation, a continuous signal of a downward trend is observed, and the best option is to either hold or open a new short position.
Exaggerated bullish divergence occurs when the price creates two bottoms on a relatively one line, while the technical indicator diverges and has a second bottom at a higher level. In this case, there is a signal to continue the uptrend, and the best choice is to hold or open a new long position.
As described above, some types of divergence can be distinguished in the Forex market, such as:
- Regular divergence or, in another way, classic.
- Hidden divergence.
- Exaggerated divergence.
Indicators for finding divergence
Forex divergence and convergence is detected by some indicators used by many traders. The most common are:
- MACD (MACD) is a Forex divergence indicator based on an assessment of exponential moving averages of a technical indicator for 26, 12 or 9 days. The MACD histogram shows those moments at which the price makes an upward or downward swing. In fact, this situation illustrates the discrepancy between price and momentum. MACD is a fairly easy to use divergence indicator.
- RSI is an indicator of the Forex divergence, which is based on the assessment of the internal strength of the stock and the subsequent comparison of the average values. Using the RSI chart is similar to using the MACD histogram, and the main task here is to identify the moment when the price and the RSI indicator begin to diverge. This may be the best indicator of divergence in the "Forex" for traders who are able to perform basic technical analysis.
- The stochastic indicator is used in divergence trading as an indicator of the amount of movement, based on an assessment of the closing price of the stock and its comparison with the price range of such stock for a certain period. The scheme of its use is exactly the same as in the two previous indicators.
Conclusion
Forex divergence indicator can be an important tool for traders to identify signals about a short-term trend change. Divergence and convergence on the "Forex" with skillful and effective use of them are able to maximize profits at times and reduce losses. It is worth developing your own divergence strategy, and then you can see how effectively it works.
How to trade with divergence?
In the charts below, you can see some good examples of how to trade when the indicators and prices diverge. The key factor that separates the professional from the average trader is that the pros combine their trading strategy with divergence and other profitable trading strategies.
In all examples included in this article, the “bullish” divergence is marked in green, and the “bearish” divergence is marked in red. The first example, the divergence of the MACD indicator, can occur between the price and the MACD line (blue) or a histogram (gray). In the figure below, you can see several examples of how to trade divergence in MACD. The first example is a bullish divergence.
A bullish pattern is formed at the lowest low in price, while the MACD lines have a double bottom. Although the hara pattern is relatively weak in and of itself, the combination of the MACD divergence adds strength to the pattern, while the hara pattern provides a laser-focused focus point to trade the MACD divergence.
The following two examples (above) show bearish discrepancies in the MACD histogram. First, the price made a double top, and the histogram made lower highs. The price then made three consecutive higher highs, while the histogram made three consecutive lower highs. In both cases, “bearish” paintings were provided, which helped to find the time.
The first two examples of a “bearish” stochastic divergence are accompanied by absorbing candle patterns, which helps to select an entry point with a high probability. However, in the last example, there was no candlestick form at the second or third maximum, so a trader can skip it.
The last chart (above) shows some examples of how to trade divergence in RSI. Learning how to spend RSI discrepancies can be difficult. You may notice that the RSI line beats up and down quite a bit, so this is not enough to base your divergent RSI trading on any RSI highs or lows.
The trader must make sure that the highs or lows that are used to diverge in the RSI correspond to different highs or lows in price. The same thing happens when trading MACD, stochastics or RSI divergence, but the problem is more pronounced with RSI.
The first example of the discrepancy in the above diagram is the “bullish” discrepancy of the RSI, which was accompanied by the “bullish” pattern of the candle “hara”. Then an example of the “bearish” divergence of RSI is given, which is accompanied by a corresponding pop-up candlestick pattern.
Conclusion
Forex divergence and convergence are a powerful tool in technical analysis. Signals of divergence should be considered only as signs of trading opportunities, and not as signals of buying or selling by themselves. Professionals always combine other trading signals with divergence to gain an advantage in the market.
Successful trading is a transaction that brings better trading solutions than 95% of other traders. This requires a profitable trading system, great psychological discipline and perfect money management. A divergence trading strategy for MACD, Stochastics or RSI can provide the necessary benefits.