How to Trade a Divergence in Forex?
Did you know that there is a low-risk way to buy near the bottom or sell near the top of a trend? It sounds profitable, doesn’t it? The way that makes this possible is Trading Divergence.
Divergences are one of the most profitable trading concepts when appropriately traded. Because they offer very reliable high-quality trading signals when used with indicators. It doesn’t matter what indicator you combined with.
Thanks to divergence, you can enter the trade better and more reliably. Not only are reversal traders using divergences, but trend-following traders can also use them to time their exits.
Guys, do you need a divergence cheat sheet? You are in the right address for it.
In this article, I will tell you about what a divergence really is and what it shows you about the price and how to trade a divergence?
Normally, price and indicator move together. It means if the price is making higher highs, the indicator should also be making higher highs. If the price is making lower lows, the indicator should also be making lower lows.
If this doesn’t happen, it means price and indicator are diverging from each other. The name also comes from here: ‘’divergence’’
A divergence is a case when price makes a higher highs but the indicator you use makes a lower lows.
In short, if your indicator looks different from the price movement, this means divergence.
Divergence is a great way to see the signals and it will be awesome to know how to use them in your trading.
There are two types of divergence: Regular and Hidden. In this article, you will learn how to detect these divergences and how to trade them.
Let’s start with Regular Divergence. You should read the full article to find the surprise that I hide for you.
A regular divergence is a possible sign used for a trend reversal. There are two types of regular divergences: Bullish and Bearish.
Regular Bearish Divergence
When price makes higher highs (HH), but the indicator makes lower high (LH), this is called a regular bearish divergence.
This divergence occurs in an uptrend. You can presumably guess the price will reverse and drop after price makes that second high and the indicator makes a lower high.
As you can see in the image below, the price reverses after making the second top.
Regular Bullish Divergence
When price makes lower lows (LL), but the indicator makes higher lows (HL), this is called a regular bullish divergence.
This divergence occurs in a downtrend. The price possibly rises after price makes the second bottom and the indicator makes a higher low.
You can see the regular bullish divergence in the image below.
The most significant advantage of the regular divergences is to help to see the tops and bottoms. You can guess where the price will stop and reverse.
Congratulations you learned the regular divergences, now it is time to learn about the second type: Hidden divergence.
Are you wondering why its name is hidden? If you are, keep reading to take the answer!
Now, you have knowledge about the regular divergences and in this section, we will handle the hidden divergences.
As divergences signal to the potential trend reversal, they can also signal a trend continuation. Trend continuation means the price continues to move in its current direction.
Note that, the divergence helps you to get a signal that the trend will continue and this is a good tip for you.
There are two types of hidden divergences as regular divergences. These are Bullish and Bearish of course.
Hidden Bearish Divergence
It happens when the price makes a lower high (LH), but the indicator makes a higher high (HH). You can easily say hidden bearish divergence occurs in a downtrend.
You can guess that the price will continue to get lower and continue the downtrend when you see hidden bearish divergence.
Hidden Bullish Divergence
Hidden Bullish Divergence happens when the price makes a higher low (HL), but the indicator makes a lower low (LL). This can be seen when the price is in an uptrend.
This means the price will continue to shoot higher and continue the uptrend. You can see the hidden bullish divergence in the image below.
Now, we finished the two types of hidden divergences and let’s summarize them.
You should take some time to identify some hidden divergences if you are a trend follower. If you do it, can help you to be aware of the trend early.
Sounds fruitful, doesn’t it!
So, what is the difference between regular and hidden divergences?
The answer is that the regular divergences are possible signals for trend reversals while hidden divergences show trend continuation.
- Regular divergences: possible trend reversal
- Hidden divergences: possible trend continuation
In the following section, I will give you some real examples of when divergences occurred and how you could have used them on your trading.
I will give you some examples of when there was a divergence between price and indicator movements. You will learn how to trade with divergences after reading this part of the article.
Firstly, I want to start with regular divergence.
How to Trade a Regular Divergence
I’ve added a daily chart image of the USD / CHF below. I’ll continue to tell the regular divergence through this image.
USD/CHF has been in a downtrend, as you can see from the falling trend line. However, it seems that the downtrend will end because there are signs that this will happen.
The indicator is showing a higher low in spite of the price moves lower lows.
You realize there’s something weird about, right? Is the reversal coming to an end? Is it a good time to buy? Look at the image below and find the answers!
Could you find? If you couldn’t find, let me tell you. It is a good time to buy when the divergence happens between the indicator and price action. The price broke the falling trend and created a new uptrend.
If you had bought near the bottom, you could have made more profit. The pair continued to shoot even higher in the following months.
So, you can see the importance of getting in on the trend early. Before continue, did you see the tweezer bottoms that occurs on the second low? You can check out all Japanese Candlesticks if you want.
Pay attention to other tips that a reversal is in place. This will give you more evidence about the end of a trend and will show the power of divergences!
Let’s pass to the next part.
How to Trade a Hidden Divergence
After we looked at the regular, now it is time to handle hidden divergence. Let’s look at the daily chart of USD/CHF once again.
As you can see in the image above, the price has been in a downtrend. And the price moves a lower high but the indicator is making higher highs.
So, this must be a hidden bearish divergence. What should we do in this situation? Will the trend continue? Let’s look at the answers!
The answer is ‘’Yes’’. Because the trend continued. The price fell almost 2,000 pips. If you’ve stayed in your position by seeing the divergence as a potential signal for a continuation of the trend, this means you have made huge profits!
Here’s a surprise for you. If you’ve read it by now, you’ve deserved this cheat sheet. This cheat sheet helps you to spot regular and hidden divergences quickly.
You can use these tables to make more consistent guesses while trading. They will help you to profit too much.
In this article, I told you the divergences. Note that the divergences are not signals to enter a trade you should use them as an indicator.
Since there are too many wrong signals, it is not wise to trade based solely on differences. It is not %100 guarantee but when used as a setup condition and combined with additional confirmation tools, divergences ensure the risk to be minimized.
Divergences don’t appear that often, but when they, you should pay attention.
Regular divergences can help you to gain a big profit when the trend changes.
Hidden divergences can help you get a bigger profit than expected by keeping you on the correct position of a trend.
It doesn’t mean you should take a position when you just because see a divergence. The important point is moving in the right place and the right time! Cya later.