Santa Anita / Ate Vitarte
Santa Anita / Ate

Trading Divergences in Forex

To determine the entry point, we use the moving averages MACD, namely their breaking the zero level downside. Usually, when the MACD moving averages go into the positive zone, it is seen as a trend reversal signal. However, taking into account hidden bearish divergence, we expect a false breakout of this level. So, when the indicator goes back into the negative zone, we enter a short trade.

These signals are good for trend trading and for filtering false signals. To confirm the short entry, we don’t need to wait until the price goes into the lower red band. We enter a trend earlier when the candlestick closes in the green zone and the MACD moving averages while the histogram goes into the negative area. We put a stop loss a little higher than the most recent local high. We should exit the trade when there is an opposite divergence signal of the trend reversal.

  1. So, when you confirm that the divergence is true, you should enter a trade opposite the trend that is exhausting.
  2. As you can see, price made a lower low, while the indicator made a higher low.
  3. Extended bullish divergence is accompanied by rising lows.
  4. It should be stressed that divergence means that the price chart and the indicator are going in opposite directions.
  5. To fix the profit, we shall use a take-profit that is twice as big as the stop loss (green line).
  6. This signal should be followed by a false trend reversal.

One of the key concepts that the MACD indicator is based on is divergence. In this article, we’ll explain what divergence in forex is, how it works, and how traders can use it in their trading strategy. It is clear from the above chart that the strategy also delivers false signals.

Bearish divergence is a regular divergence occurring in a bull trend and could indicate a trend reversal. A negative bearish divergence indicates the bearish trend continuation. You see that before a reversal signal, there was a divergence on the MACD histogram (marked with a circle). I must tell that the MACD moving averages do not confirm this signal. However, such multiple convergence divergence only increases the total chance that the divergence would work out. Using the combination of MACD and Bollinger Bands as an example, we see that trend lines and other oscillators can be used to filter the divergence signal.

When this trend is over, the indicator gives a divergence signal again, which is now located, as though inside the previous signal. This may continue until the global trend changes. On the other hand, 40 different types of arbitrage trading strategies hidden divergence occurs when the price makes lower highs or higher lows, while the indicator makes higher highs or lower lows. Hidden divergence suggests that the current trend is likely to continue.

Quantitative Trading Guide

The above chart shows an example of the bullish divergence stochastic. You see that the same rules work as for the MACD. The second low of the indicator is lower than the first one in an uptrend.

I used the default settings for the Relative Strength Index. We shall take the profit (green line) when the indicator goes into the oversold zone after the meeting of %K and %D stochastics. This signal is marked with the green circle in the above chart. Now let see practical trading divergence signals in different financial markets. On many Forex trading websites, I noticed that authors wrongly identify divergence. They suggest that if the indicator is moving up, the line drawn across the indicator peaks is showing real highs.

In technical analysis, reversals are important, as traders can profit from a new trend. A reversal can occur after a divergence when the indicator signals a change in market sentiment. Also, a reversal can occur after reaching a key level or when the price goes beyond the trend line.

Understanding Divergence Forex: A Beginner’s Guide

It turns out that the divergence between the Stochastic and price action was a good signal to buy. Divergence signals tend to be more accurate on the longer time frames. 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. The highs or lows you identify on the indicator MUST be the ones that line up VERTICALLY with the price highs or lows. In a nutshell, divergence can be seen by comparing price action and the movement of an indicator.

Extended Divergences

We can see from the falling trend line that USD/CHF has been in a downtrend. Gordon Scott has been an active investor and technical analyst or 20+ years. All you can do now is wait for another swing high/low to form and start your divergence search over. 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. Once you see two swing highs are established, you connect the TOPS.

Divergence principles will work with any technical indicator. So, you can use any oscillator that suits you best. When you use trendline to detail entry points, you should be able to draw it correctly. The downward trendline starts from the first trend high to the last local highest high in our example. In the previous example, with the bullish trend, the approach was the same, but the trendline was drawn across the lows.

Thus, the OBV indicator shows the relative strength of bulls and bears in the market. In the case of the inverse divergence, you set a stop loss beyond the local price extreme that is within the divergence pattern. So, having learned the theory and the practical application of divergence, we can make up a step-by-step guide to trading divergence in forex. Differently put, there should be two manifested highs or lows in the chart.

Traders often describe such situations as the trend is exhausting. It should be stressed that divergence is a leading signal, while confirmation and reversal reflect the current market state. Convergence derives from the Latin word ‘convergo’ – get close. Therefore, convergence is a type of divergence, when the price trend and the indicator line are meeting. The above chart displays the correct analysis of divergence. The indicator highs coincide with the price highs at the double top.

In early May, the EURUSD pair enters the upper red zone and breaks it through. Besides, the price diverges from both the MACD and the MACD histogram as well, which is an additional confirmation. If you discover such as signal moving average convergence divergence macd, the trend must soon reverse. It should be stressed that divergence means that the price chart and the indicator are going in opposite directions. Divergence can indicate a trend reversal or a trend continuation, depending on its type. The main feature of divergence is that it is a leading signal.

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