How To Trade Divergences
Now it’s time to put those Jedi-divergence mind tricks to
work and force the markets to give you some pips!
Here we’ll show you some examples of when there was
divergence between price and oscillator movements.
First up, let’s take a look at regular divergence. Below is
a daily chart of USD/CHF.
We can see from the falling trend line that USD/CHF has been
in a downtrend. However, there are signs that the downtrend will be coming to
an end.
While price has registered lower lows, the stochastic (our
indicator of choice) is showing a higher low.
Something smells fishy here. Is the reversal coming to an
end? Is it time to buy this sucker?
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every thought that weakens you must be rejected."
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Recap About Hidden Divergence
If you’re a trend follower, then you should dedicate some
time to spot some hidden divergence.
If you do happen to spot it, it can help you jump in the
trend early.
Sounds good, yes?
Okay, now you know about both regular and hidden divergence.
We hope you got it all down pat. Keep in mind that regular
divergences are possible signals for trend reversals while hidden divergences
signal trend continuation.
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Hidden Divergence
Lastly, we’ve got hidden bearish divergence. This occurs
when price makes a lower high (LH), but the oscillator is making a higher high
(HH). By now you’ve probably guessed that this occurs in a downtrend. When you
see hidden bearish divergence, chances are that the pair will continue to shoot
lower and continue the downtrend.
"Success is not final, failure is not fatal; it is the
courage to continue that counts."
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"Successful people always carry two things on their
face “SMILE AND SILENCE” which is “SMILE
TO SOLVE PROBLEMS” AND “SILENCE TO AVOID PROBLEMS”."
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Hidden Divergence
Divergences not only signal a potential trend reversal; they
can also be used as a possible sign for a trend continuation. Always remember,
the trend is your friend, so whenever you can get a signal that the trend will
continue, then good for you!
Hidden bullish divergence happens when price is making a
higher low (HL), but the oscillator is showing a lower low (LL).
This can be seen when the pair is in an uptrend. Once price
makes a higher low, look and see if the oscillator does the same. If it doesn’t
and makes a lower low, then we’ve got some hidden divergence in our hands.
"The problem with the world is that the intelligent
people are full of doubts while the stupid ones are full of confidence."
By Charles Bukowski.
Regular Divergence
As you can see from the images
above, the regular divergence is best used when trying to pick tops and
bottoms. You are looking for an area where price will stop and reverse.
The oscillators signal to us that
momentum is starting to shift and even though price has made a higher high (or
lower low), chances are that it won’t be sustained.
See the regular bearish divergence
at work through this GBP/USD trade handpicked by Pipcrawler!
Did you get all of that? Pretty
simple eh?
Now that you’ve got a hold on
regular divergence, it’s time to move and learn about the second type of
divergence – hidden divergence.
Don’t worry, it’s not super
concealed like the Chamber of Secrets and it’s not that tough to spot. The
reason it’s called “hidden” is because it’s hiding inside the current trend.
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Regular Divergence
A regular divergence is used as a
possible sign for a trend reversal.
If price is making lower lows (LL),
but the oscillator is making higher lows (HL), this is considered to be regular
bullish divergence.
This normally occurs at the end of
a down trend. After establishing a second bottom, if the oscillator fails to
make a new low, it is likely that the price will rise, as price and momentum
are normally expected to move in line with each other.
The image shows that portrays regular bullish divergence.
Now, if the price is making a
higher high (HH), but the oscillator is lower high (LH), then you have regular
bearish divergence.
This type of divergence can be
found in an uptrend. After price makes that second high, if the oscillator
makes a lower high, then you can probably expect price to reverse and drop.
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Divergence Trading
Higher Highs and Lower Lows
Just think “higher highs” and “lower lows”
Price and momentum normally move hand in hand like Hansel
and Gretel, Batman and Robin, Serena and Venus Williams, salt and pepper…You
get the point.
If price is making higher highs, the oscillator should also
be making higher highs. If price is making lower lows, the oscillator should
also be making lower lows.
If they are NOT, that means price and the oscillator are
diverging from each other. And that’s why it’s called “divergence.”
Divergence trading is an awesome tool to have in your
toolbox because divergences signal to you that something fishy is going on and
that you should pay closer attention.
Using divergence trading can be useful in spotting a
weakening trend or reversal in momentum. Sometimes you can even use it as a
signal for a trend to continue!
There are TWO types of divergence:
-Regular
-Hidden
In this grade, we will teach you how to spot these
divergences and how to trade them. We’ll even have a sweet surprise for you at
the end.
"Just keep going. Everybody gets better if they keep at
it."
By Ted Williams.
Divergence Trading
What if there was a low risk way to
sell near the top or buy near the bottom of a trend?
What if you were already in a long
position and you could know ahead of time the perfect place to exit instead of
watching your unrealized gains, a.k.a your potential Aston Martin down payment,
vanish before your eyes because your trade reverses direction?
What if you believe a currency pair
will continue to fall but would like to short at a better price or a less risky
entry?
Well guess what? There is a way!
It’s called divergence trading.
In a nutshell, divergence can be
seen by comparing price action and the movement of an indicator. It doesn’t
really matter what indicator you use. You can use RSI, MACD, the stochastic,
CCI, etc.
The great thing about divergences
is that you can use them as a leading indicator, and after some practice it’s
not too difficult to spot.
When traded properly, you can be
consistently profitable with divergences. The best thing about divergences is
that you’re usually buying near the bottom or selling near the top. This makes
the risk on your trades are very small relative to your potential reward.
Cha-ching!
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Summary: Harmonic Price Patterns
The three basic steps in spotting
harmonic price patterns are the following
Step 1: Locate a potential harmonic
price pattern
Step 2: Measure the potential
harmonic price pattern
Step 3: Buy or sell on the
completion of the harmonic price pattern
Again, harmonic price patterns are
so perfect that they are very difficult to spot.
More than knowing the steps, you
need to have hawk-like eyes to spot potential harmonic price patterns and a lot
of patience to avoid jumping the gun and entering before the pattern is
completed.
With enough practice and experience,
trading using harmonic price patterns can yield a lot of pips!
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Summary: Harmonic Price Patterns
Harmonic price patterns enable us to distinguish possible
areas for a continuation of the overall trend.
There are six harmonic price patterns:
-The ABCD Pattern
-The Three-Drive Pattern
-The Gartley Pattern
-The Crab Pattern
-The Bat Pattern
-The Butterfly Pattern
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Third Step in Trading Harmonic Price Patterns
Step 3: Buy or sell on the
completion of the Harmonic Price Pattern
Once the pattern is complete, all
you have to do is respond appropriately with a buy or sell order.
In this case, you should buy at
point D, which is the 1.272 Fibonacci extension of move CB, and put your stop
loss a couple of pips below your entry price.
Is it really that easy?
Not exactly.
The problem with harmonic price
patterns is that they are so perfect that they are so difficult to spot, kind
of like a diamond in the rough.
Check out this excellent forum
thread discussing Gartley setups.
More than knowing the steps, you
need to have hawk-like eyes to spot potential harmonic price patterns and a lot
of patience to avoid jumping the gun and entering before the pattern is
completed.
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Second Step in
Trading Harmonic Price Patterns
Step 2: Measure the potential
Harmonic Price Pattern
Using the Fibonacci tool, a pen,
and a piece of paper, let us list down our observations.
1.Move BC is .618 retracement of
move AB.
2.Move CD is 1.272 extension of
move BC.
3.The length of AB is roughly equal
to the length of CD.
This pattern qualifies for a
bullish ABCD pattern, which is a strong buy signal.
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