Hello community members, my this article is about Divergence Trading. which is a great tool when it comes to trading forex. we shall learn about the facts and ways to trade divergence. And how we can use it to be profitable in long run.
Sell High - Buy Low

What if there is way to sell near the top or buy near the bottom of a trend ? And if you are already in a long position and you could know ahead of time the perfect place to exit instead of watching your unrealized gains.

Well, There is a way! It’s called Divergence Trading !!

Divergence can be seen by comparing price action and the movement of an indicator. It does not really matter what indicator you use. You can use RSI ,MACD , CCI and the stochastic. The great thing about divergences is that you can use them as a leading indicator. When traded properly, you can be consistently profitable with divergences. The best thing about divergences is that you are usually buying near the bottom or selling near the top. This makes the risk on your trades are very small relative to your potential reward.

How to find out Trading Divergences : The price and the indicators normally move hand in hand. 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 / indicator are diverging from each other. And that’s why it’s called “divergence.” Easy to understand, Right ?
Divergence trading is an awesome tool to have in your toolbox because divergences signal to you that something fishy is going on and that you should pay closer attention. Using divergence trading can be useful in spotting a weakening trend or reversal in momentum. Sometimes you can even use it as a signal for a trend to continue! you ll learn it as we proceed further.

Types of Divergence :There are TWO types of divergence
  1. Regular
  2. Hidden
1. Regular Divergence : A "regular divergence" is used as a possible sign for a "trend reversal". There are two types of regular divergences: bullish and bearish.
  • Regular Bullish Divergence: If price is making lower lows, but the oscillator is making higher lows, this is considered to be regular bullish divergence. This normally occurs at the end of a "DOWNTREND". After establishing a second bottom, if the oscillator fails to make a new low, it is likely that the price will rise, as price and momentum are normally expected to move in line with each other. I show you an example below.

  • Regular Bearish Divergence : Now, if the price is making a higher high, but the oscillator is making lower high , then you have regular bearish divergence. This type of divergence can be found in an "UPTREND". After price makes that second high, if the oscillator makes a lower high, then you can probably expect price to reverse and drop. In the image below, we see that price reverses after making the second top.

The regular divergence is best used when trying to pick tops and bottoms. You are looking for an area where price will "stop and reverse". The oscillators signal to us that momentum is starting to shift and even though price has made a higher high (or lower low), chances are that it won’t be sustained.

2. Hidden Divergence : Divergences not only signal a potential trend reversal, they can also be used as a possible sign for a trend continuation. A "Hidden divergence" is used as a possible sign for a "trend Continuation". There are two types of regular divergences: bullish and bearish.
  • Hidden Bullish Divergence: This can be seen when the pair is in a "UPTREND". Once price makes a higher low , look and see if the oscillator does the same. If it doesn’t and makes a lower low (LL), then we’ve got some hidden divergence in sight. and we can enter long and continue the "UPTREND".
  • Hidden Bearish Divergence : This occurs when price makes a lower high, but the oscillator is making a higher high. By now you have probably guessed that this occurs in a "DOWNTREND".When you see hidden bearish divergence, chances are that the pair will continue to shoot lower and continue the downtrend.

Keep in mind that :
  • Regular divergences = signal possible trend reversal
  • Hidden divergences = signal possible trend continuation
Note: Keep an eye out for other clues that a reversal is in place. This will give you more confirmation that a trend is coming to an end, giving you even more reason to believe in the power of divergences.

How to Trade a Hidden Divergence: In trying to trade divergences, you might get early into the market which may lead to losses. There are some rules that one should follow to minimize the risk.

Just wait for a crossover of the momentum indicator: This would indicate a potential shift in momentum from buying to selling or vice versa. The main reasoning behind this is that you are waiting for top or bottom and these can’t be formed unless a crossover is made. In order for divergence to exist, price must have either formed one of the following:
  • Higher high than the previous high
  • Lower low than the previous low
  • Double top
  • Double bottom
Don’t even bother looking at an indicator unless ONE of these four price scenarios have occurred. If not, you are not trading a divergenceConnect the TOPS and BOTTOMS only and correctly. and they should be in same line as well.

Divergence only exists if the slope of the line connecting the indicator tops/bottoms differs from the slope of the line connection price tops/bottoms. The slope must either be: Ascending (rising), Descending (falling), Flat (flat). If you spot divergence but the price has already reversed and moved in one direction for some time, the divergence should be considered played out.

Divergence signals tend to be more accurate on the longer time frames. That means you get less false signals.This means fewer trades but if you structure your trade well, then your profit potential can be huge. Divergences on shorter time frames will occur more frequently but are less reliable. Now go scan the charts and see if you can spot some divergences that happened in the past as a great way to begin getting your divergence skills up to par!
Note: Please keep in mind that we use divergence as an indicator, not a signal to enter a trade. It would not be smart to trade based solely on divergences since 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. Good Luck!!
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