Forex indicators are mathematical functions based on the evaluation of the difference between bidding and price. While analyzing charts, a trader can predict whether a current trend will be the same or change somehow and thus create his own most profitable trading strategy. By using divergence indicators, traders may effectively reveal higher and lower momentum, and therefore the possible trend continuation or reversal. Effectively using the forex divergence trading system may be one of the best tools to forecast the situation and to achieve the best trading results.

CONTENTS
1. What is divergence
2.Types of divergence
3. Indicators to use for Divergence Trading
4. Rules for Determining Divergence
5.Divergence Trading – Some important points
6.conclusion

1.WHAT IS DIVERGENCE

It is an age-old concept that was developed by Charles Dow and mentioned in his Dow Tenets. The most important of all is when Dow found out that when there was a divergence between the two, it presented a possible change in the markets. For example, when the Dow Industrials made new highs and when the transportation index failed to make a high it indicated that there was some discrepancy. This formed the basis of divergence theory which was soon developed into a trading system on its own.
So, in the context of the forex markets, when price makes a new high, the oscillator also should make a new high. Or when prices make a new low, the oscillator should ideally make a new low. When there is a discrepancy between price and the oscillator a divergence is identified.





2.TYPES OF DIVERGENCE

There are 4 types of divergence, which are broadly classified into two categories:
2.1 Regular or Classic Divergence
2.2 Hidden Divergence

The table below gives a brief summary of various divergences



2.1.1 BEARISH DIVERGENCE:



The bearish divergence is shown in the above chart with price making a higher high but RSI making a lower high. A sell position at the small resistance prior to the high with stops at the recent high targeting the low formed during the divergence shows a high probability trade potential.

2.1.2 Bullish Divergence :



The bullish divergence chart above shows price making a lower low while the RSI makes a higher low. A long position can be entered at the top of the bounce after the second low is made with stops at or below the second low with the target to the high formed during the divergence.

2.2.1 Hidden Bearish Divergence:



The above chart shows a hidden bearish divergence as price makes a lower high and RSI makes a higher high. The hidden bearish divergence occurs in a downtrend and signals continuation. Therefore, short positions can be taken on the low formed during the divergence to trade in the direction of the trend.

2.2.2 Hidden Bullish Divergence:



The chart above shows a hidden bullish divergence. Price makes a higher low, while the oscillator makes a lower low. Buying on the break of the previous minor rally with stops near or below the second low of price offers a good risk/reward trade, targeting the previous high that was formed.

3. Indicators to use for Divergence Trading

A number of different forex divergence indicators may be used in forex divergence trading. The most common ones of them are the following:

3.1 MACD (Moving Average Convergence/Divergence):



  • This type can become the basis for the entire trading system.
  • It depicts the direction of the market by means of moving averages, calculating the distance between them.
  • When the line crosses the zero-mark upwards, there is a signal to buy, if downward, then selling will be the right step, following the divergence trading.
  • Traders pay much attention to constant descending or ascending market (when MACD is below or above zero) because it is better time to act.

3.2 RSI (Relative Strength Index):



  • It enters the range from 0 to 100 with two additional levels (70 and 30)
  • The simple formula is the following: RSI = Σ blue candles / Σ white candles x 100%.
  • Traders consider RSI to be one of the best Forex indicators to use because of its accuracy.
3.3 CCI divergence indicator (Commodity Channel Index):



  • Donald Lambert made this instrument founding on a typical price and simple middle average.
  • Typical price is (maximum + minimum + close price) ÷ 3.
  • Here the middle average is less sensitive to the close price, thus informing about when a trend becomes weaker or is closed.
  • The exponents of the CCI fluctuate between -100 and +100.
  • In case the line is lower -100, it means that, for instance, a stock is oversold and its price will grow.
  • If the line is above +100, then a stock is overbought and its price will become lower.

3.4 Stochastic:



  • This kind shows a ratio of the current close price to maximum or minimum in the set period of time in a chart.
  • There are 3 types of stochastic: fast, slow and full, depending on a mathematical calculation.
  • It works perfectly on the non-trend period.

4 Rules for Determining Divergence/How to Trade Divergence :

  • The presence of a trend is obligatory; divergence does not work in flat.
  • In addition to divergence, you should confirm entries using Price Action.
  • Do not expect that you have found a 100% signal. There is always the possibility of an error. Therefore, when performing trading operations, you should observe general trading rules.
  • Do not determine divergence based on candlesticks that are constructed using news indicators. Due to high volatility during news releases, such candlesticks often produce false signals.
  • The divergence must be explicit. You must be sure that the signal is visible not only to you but also to the other market participants. The chance of making the right decision may increase only in this case.
  • Only analyze nearest peaks and troughs. This gives a clearer understanding of the situation. When using trend indicators, such as MACD, the intersection of the zero line may weaken the signal or even cancel it.


5. Divergence Trading – Some important points :

Divergence trading is easy and can be traded on any time frame. It can be used with MACD, RSI or any other oscillator for that matter. For best analysis in divergence trading, it is advised to make use of the line chart, especially when using the RSI and it is easier to spot the divergences. Candlesticks or bar charts are not ideal chart types to use with divergence trading due to the wicks. The lines chart represent closing prices, which is what RSI (or any other oscillator) tracks. Therefore line charts are better to identify divergence trading opportunities.
When trading with divergences, never take a position at the high or the low, but at the immediate support/resistance levels. In most cases, prices will continue to make another attempt to make a low or a high, which is usually done by the market to hunt for any stops placed by early traders who want to get more pips from their divergence trades.

6. Conclusion :

The divergence indicator in forex may be an essential tool for traders to identify signals of a close market trend reversal. Through the effective use of forex divergence and convergence, to may be able to avoid possible losses and maximize your profits. Develop your own best divergence strategy of forex trading, and you will see how convenient it may be a how effectively it will fill up your trader's
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