Trading Strategy: How to trade divergence with technical indicators

So for a few years, I bounced around different systems, blowing accounts and giving back profits I had managed to make. He calls his trades live, shares his results AND records a weekly trade analysis video. His custom indicators for the MT4 MetaTrader platform, as a download at the end of the book. AND anyone who has received these indicators will also receive the MT5 version of his files when they have been programmed. This example uses MACD indicator as a Forex divergence indicator. Bookshop.org needs to review the security of your connection before proceeding.

divergence forex

As the name suggests, this is when the indicator changes direction but the price trend does not reverse as the indicator suggested. This will quite often happen when the indicator gets very overbought divergence forex or oversold. The momentum of the trend will weaken but the trend remains in tact. A security which is in strong uptrend will rarely fall below 40 and usually moves between 40 and 80 levels.

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At the point that momentum wanes, you then scale out of the position by taking progressive profits on your fractional trades. Divergences are used by traders in an attempt to determine if a trend is getting weaker, which may lead to a trend reversal or continuation. The Relative Strength Index measures the magnitude of recent price changes on a scale from 0 to 100 to identify when a market is overbought or oversold. When the RSI line rises above 70 or dips below 30, the market is indicated as overbought or oversold respectively. In the chart below, the price of GBP/JPY makes a higher high, while the Stochastic Oscillator makes a higher low in the same period. This formation suggests the price is losing upward momentum and foreshadows a bearish reversal. Nearly any leading indicator can be used, as long as you know how to spot divergences.

  • 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.
  • At the same time, it is clearly outside the window, and you see that everything is in order with the plane.
  • Usually divergence is hidden and not immediately obvious until it has occurred.
  • If the trade becomes favorable, on the other hand, you can continue to scale in until your intended trade size is reached.
  • This kind of divergence occurs when the market is upward, drawing high lows, and the indicator reading lower.
  • From your FlowBank trading application you can right click on your chart and select indicators.

So how can we best maximize the profit potential of a divergence trade while minimizing its risks? First of all, although divergence signals may work on all timeframes, longer-term charts usually provide better signals. For the divergence forex first signal , which occurred between November and December of 2006, we have almost a textbook case of classic bullish divergence. Price drastically hit a lower low while the MACD histogram printed a very obvious higher low.

Momentum Indicators

Samantha Silberstein is a Certified Financial Planner, FINRA Series 7 and 63 licensed holder, State of California life, accident, and health insurance licensed agent, and CFA. She spends her days working with hundreds of employees from non-profit and higher education organizations on their personal financial plans. Nine rules you MUST (should?) follow if you want to seriously consider trading using divergences. Divergence signals tend to be more accurate on the longer time frames. Maintain vertical alignment with the PRICE’s swing highs and lows with the INIDCATOR’s swing highs and lows. Some indicators such as MACD or Stochastic have multiple lines all up on each other like teenagers with raging hormones.

You should consider whether you understand how over-the-counter derivatives work and whether you can afford to take the high level of risk to your capital. Investing in over-the-counter derivatives carries significant risks and is not suitable for all investors.

Overbought RSI Signal

And the orange lines on the RSI indicator mark a negative divergence, shown by the RSI. You should always use a stop loss order when trading RSI divergence. Since you https://www.forex.com/ will get some fake signals, it is good that you stay protected during any bad trades. In different cases, these two requirements will look different on the chart.

Negative RSI Divergence

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Like other technical indicators, it is based on price, so it does not differ much from them in terms of performance. By the way, the ratio of traders’ positions can also be called divergence. After all, this is also a discrepancy when the majority is buying, and the price goes down. Hidden divergences exhibit similar patterns as regular divergences, but the lower highs or higher lows occur in the price chart instead of the indicator. Hidden divergences indicate that the price trend will continue. To date i have not found a trading strategy with a higher winning percentage than divergence combined with support and resistance levels. Inmy own trading strategy, divergences are a big part for one of my setups and in combination with other signals.

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