Why does divergence occur

Now draw a line backward from that high or low to the previous high or low. Now look at your preferred technical indicator and compare it to price action. Some indicators such as MACD or Stochastic have multiple lines all up on each other like teenagers with raging hormones.

If you draw a line connecting two highs on price, you MUST draw a line connecting the two highs on the indicator as well. Ditto for lows also. If you draw a line connecting two lows on price, you MUST draw a line connecting two lows on the indicator. They have to match! 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.

You missed the boat this time. Forex divergence is all about comparing price action and the movement of a particular indicator most commonly - an oscillator. Most of the time, if the price is reaching higher highs, the oscillator should follow it by also making higher highs.

Vice-versa, if the price is posting lower lows, the oscillator should follow by also making lower lows. However, if that doesn't occur, it means the price and the oscillator are diverging from each other. Divergence is one of the strongest reversal signals you can get. But do keep in mind, this is a reversal trading strategy whereby you are fading the current trend.

Forex divergence should not be used as an entry signal itself. However, it could be a valuable addition to your existing strategy. For example, if your strategy tells you to sell a currency pair at a major resistance level, you could incorporate the divergence pattern into your plan as an additional confirmation signal. Spotting the difference is very simple. Confirmation is occurring when the indicator is moving in the same direction as the price. Rising prices are accompanied by an indicator that is moving higher too.

Vice versa, if the price is moving down, the indicator is following it lower. Divergence is easy to spot on a live price chart but it can sometimes be confusing what type of divergence you are seeing. In forex trading , we generally divide divergences into regular, hidden or extended. Regular divergence will suggest a strong trend reversal signal. Regular divergence subdivides into:. Hidden divergence is the opposite of regular divergence in forex trading, and it suggests that the trend continues.

Hidden divergence subdivides into:. Extended divergence is the third type and is somewhat similar to hidden divergence. Some traders don't consider it to be as strong a signal as it often fails to observe the basic rules for divergence and will occasionally occur in sideways trends.

Extended divergence subdivides into:. Regular bullish divergence occurs when the price is making lower lows, but the oscillator is posting higher lows. This could signal a trend reversal and indicate that a recovery might follow. Regular bearish divergence can be spotted when the price is making a higher high, but the oscillator is posting a lower high.

This could signal that the existing uptrend is running out of momentum and that a retracement might follow. Divergence can also signal a potential trend continuation. Let's have a look at hidden divergence. A hidden bullish divergence occurs when the pair is in an uptrend, the price is making higher lows, but the indicator is posting lower lows at the same time.

This could signal a continuation of the uptrend. On the other hand, a hidden bearish divergence will appear in a downtrend when the price is making lower highs, but the oscillator is making higher highs at the same time. This could signal that the downtrend is likely to resume. Another important point is by managing expectations with regard to divergence. There is a substantial difference between the pip size of a reversal and a retracement.

Be careful to reckon and plan on both in your trading plan. One way of distinguishing between the two is by looking at the time frame. If a trader is observing a 15 min or 1-hour divergence, the divergence will most likely create a pause or retrace within a bigger trend continuation.

If a higher time frame has divergence, the likelihood of a trend reversal is higher. Also, the likelihood of a trend reversal increases if double or even triple divergence is spotted. In Elliott Waves term this is explained by the divergence between Wave 3 and 5 of a bigger Wave 3. And then the divergence between bigger Wave 3 and 5. A trader can also decrease the risk of divergence trading by only trading divergences when they occur on multiple time frames.

The likelihood of a bounce increases when more time frames show diverging movements between price and momentum. While regular divergence is especially useful for cautiously predicting the end of a trend, hidden divergence can be a good indication of trend continuation. Hidden bullish divergence takes place when the price is making a higher low HL. But the oscillator is showing a lower low LL.

In an uptrend hidden divergence happens when the price makes a higher low but the oscillator makes a lower low. A hidden bearish divergence occurs when the price makes a lower high LH. But the oscillator is making a higher high HH. In a downtrend, hidden divergence happens when the price makes a lower high but the oscillator makes a higher high. Do you want to start trading divergence and convergence, but you have no idea from where to start?

Divergence can only be displayed on the price chart if the price forms a double top, double bottom, a higher high than the previous high or a lower low than the previous low. They have to match. The swing high must correspond to an equivalent high on the indicator. Simply draw an imaginary vertical line from the price to the indicator, to rapidly spot the corresponding high points. For bullish divergence, we look to connect lows on the price action and lows on the indicator as well.

Divergence can only exist if we have an ascending slope or descending slope either on the price action or on the indicator itself. The bigger the divergence slope is the higher the chances of a price reversal are. And, not just that, but also the profit potential increases exponentially.

The key takeaway is that you can put more weight on the regular divergences that have steep slopes. The smart way to trade divergence is as soon as they happen. Memorize it, save it on your desktop and use it whenever you feel confused about the price action. Like all trading strategies, remember that using Convergence Divergence indicators require a certain degree of risk. By keeping this simple strategy in mind, you can increase your winning percentage and practice unique trading opportunities.

Please be careful when implementing this method in your strategies. Make sure to do proper backtesting and incorporate other tools and time frames to confirm the divergence and convergence readings. Have a great Friday, weekend and Good Trading! We specialize in teaching traders of all skill levels how to trade stocks, options, forex, cryptocurrencies, commodities, and more.

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