Divergence Trading Strategy

The theory behind divergence, its identification and trading signals were discussed briefly in the previous article about divergence. Here in this article divergence trading strategy in forex will be discussed.

Divergence trading strategy along with other indicators for confirmation is one of the best strategies. It avoids us form too early entry and late exit. It is necessary to use a few others tool because no indicator is foolproof. Therefore to make a trading decision, rely on divergence along with other confirmation indicators. Divergence in higher timeframe doesn’t appear frequently, once appeared they are more reliable and ultimately more profitable. On the other hand in shorter time frame divergences appear more frequently but are less reliable. After identifying divergences they need to be analyzed with other tools more precisely for positive results.

Contents

4 Golden Rules To Trading Divergence

Bearish Divergence

  1. Identify Successive Peaks
  2. Higher-High and Higher-Low
  3. Bearish Divergence Confirmation
  4. Trading Bearish Divergence

Bullish Divergence

  1. Identify Successive Bottom
  2. Lower-Low and Higher-Low
  3. Bullish Divergence Confirmation
  4. Trading Bullish Divergence

In every trading strategy, there are few basic and important considerable rules to follow. While trading with divergence in forex the following are the key point to consider before opening any order. If none of the following occurs it means there is no opportunity to trade with divergence. If any of the following is identified then it means divergence pattern is identified and there is a trading opportunity.

4 Golden Rules For Trading Divergence

There are four golden rules for trading divergences every divergence trader must be fully aware of. First of all for a successful divergence trading strategy, identify successive peaks or bottoms, secondly, identify higher-high or lower-lows, thirdly make a confirmation with the help of other indicators and finally open a position accordingly. Each of them is explained below with an image for bullish and bearish divergences.

Bearish Divergence

Bearish Divergence Trading Strategy, Higher High, indicators crossover, candlestick confirmation, stochastic indicator, bulls candle, bear candle, downtrend, up trend, black background

Bearish Divergence Trading Strategy by Let’s Forex

The following are four golden rules for bearish divergence trading. In a divergence trading strategy, each of the rules is equally important and need to consider while trading with divergence.

1.      Identify Successive Peaks

The first rule to trade a bearish divergence is identifying successive peaks in price and its reflective indicator windows. After identification of peaks, the next step is of drawing a trend line on peaks of price and indicator.

2.      Higher-High and Higher-Low

The trend lines will indicate whether the peaks are making higher-highs and lower-lows or not, in price and indicator window respectively. The price must make higher-highs. This means the latest peak/top is at a higher level as compared to the previous one. Therefore, the trend line is rising (steeping) or getting flattered in a rising direction.

Similarly, the indicator must make a higher-lows. This means the latest peak/top of the indicator is at a lower level as compared to the previous high. As a result, the trend line in on indicator is falling/downward sloping.

The higher-highs and higher-lows indicate the existence of bearish divergence.

3.      Bearish Divergence Confirmation

The trendlines will confirm bearish divergence if the trend line in the price window needs to be flattering upward and downward sloping in the indicator window.

The following candlesticks will confirm bearish divergence.

Gravestone Doji, Hanging Man, Shooting Star, Bearish Engulfing, Dark Cloud Cover, Tweezer Top, Double Top, Triple Top, Head And Shoulder, Rising Wedge, Bearish Rectangle, Bearish Pennant or any other bearish reversal pattern occurs.

Finally, the most important thing to consider for confirming divergence is to get familiar with trends in the higher time frame.

4.      Trading Bearish Divergence

With the identification and confirmation of bearish divergence finally, it is time for trading a bearish divergence (open a short order). But keep in mind stop loss and take profit must be in their place according to support and resistance levels. Fund management rules are key to secure and steady growth of the account.

Bullish Divergence

bullish Divergence Trading Strategy, Lower low, indicators crossover, candlestick confirmation, stochastic indicator, bulls candle, bear candle, downtrend, up trend, black background

Bullish Divergence Trading Strategy by Let’s Forex

The following are four golden rules for bullish divergence trading. In a divergence trading strategy, each of the rules is equally important and need to consider while trading with divergence.

1.      Identify Successive Bottom

The first rule to trade a bullish divergence is identifying successive bottoms in price and its reflective indicator windows. After identification of bottoms, the next step is of drawing a trend line by connecting bottoms of price and indicator.

2.      Lower-Low and Higher-Low

The trend lines will indicate whether the bottoms are making lower-lows and higher-lows or not, in price and indicator window respectively. The price must make lower-lows. This means the latest bottom is at a lower level as compared to the previous one. Therefore, the trend line is falling or getting flattered in a downward direction.

Similarly, the indicator must make a higher-lows. This means the latest bottom of the indicator is at a higher level as compared to the previous low. As a result, the trend line in an indicator is rising.

The lower-lows and higher-lows indicate the existence of bullish divergence.

3.      Bullish Divergence Confirmation

The trendlines will confirm bullish divergence if the trend line in the price window is flattering downward and the trend line is sloping upward in the indicator window.

The following candlesticks will confirm bullish divergence.

Dragonfly Doji, Hammer, Inverted Hammer, Bullish Engulfing, Piercing, Tweezer Bottoms, Double Bottom, Triple Bottom, Inverse Head And Shoulder, Falling Wedge, Bullish Rectangle, Bullish Pennant or any other bullish reversal pattern occurs.

Finally, the most important thing to consider for confirming divergence is to get familiar with trends in the higher time frame.

4.      Trading Bullish Divergence

With the identification and confirmation of bullish divergence finally, it is time for trading bullish divergence (open a long order). But keep in mind stop loss and take profit must be in their place according to support and resistance levels. Fund management rules are key to secure and steady growth of the account.

Divergence Indicators

Trend lines and candlestick patterns are best to confirm reversal and continuation of a trend. Ultimately candlesticks and trend lines will give us confirmation of divergences as it confirms reversals and continuation of trends. Momentum indicators like Moving Average Convergence and Divergence (MACD), Relative Strength Index (RSI), Stochastic, Commodity Channel Index (CCI) are best to use in divergence trading strategies. They are also helpful to indicate overbought and oversold levels. Crossovers in momentum indicators are key to identify divergence. The breaking of trend lines by both price and momentum indicator gives us a confirmation of divergence and entry signals.

Key Terms:

Forex, Divergence, Divergence Strategy, Bullish divergence, Bearish divergence, Candlesticks, RSI, MACD, CCI, Stochastic

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