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In Divergence Trading Strategy, it simply means a contrary move of the oscillator in relation to the price on the chart. It is one of the best concepts in trading. It is often overlooked but when perfected could help change the prospect of a trader and give more wins over time.
It’s a leading indication that price is about to change direction and reverse a trend to a new direction or continue in the original trend. Some indicators used to identify divergence are the MACD, OSMA, RSI, CCI, STOCHASTIC.
There are two types of divergence, the Regular and the Hidden divergence.
The Regular divergence is seen when a trend is about to end. As you may know in an uptrend, when the price is making higher highs and lower highs, most traders would want to know when the trend is getting weak, one easy way to know this is with the use of the regular divergence.
The Hidden divergence however is different in the sense that it is a signal of a trend continuation, and is identified when the reversal of a trend is ending and the trend wants to continue. Below is a bullish hidden divergence.
As we can see on the above chart, as the price was going high there can be a time when we witness a slight retracement (some buyers are taking profit, and price weakens), but because there is still strength in more buyers the price continues going higher. The indicator shows a contrary move at this time telling us that the market is ready to continue on its original trend.
In the chart below we have both the stochastic and OSMA showing us divergences.
It’s easy to get excited about this concept because, when you get used to identifying divergences on the chart. We could start trading and fall for the drawbacks of this strategy. Sometimes divergences fail, especially the regular divergences. So we could see a regular divergence and notice that it’s just a minor retracement. Price then continues in the original trend.
The best way to trade divergence is to follow the trend. Use the hidden divergence to enter trades or identify regular divergences on the retracements of the general trend. To do this correctly, we first identify the hidden divergence (OSMA). Then go to the lower time frame and identify a regular divergence (Stochastic) at the area where we have seen the hidden divergence on the higher time-frame.
The chart above shows a hidden divergence on 1H. We go to 30m to identify and trade when we see regular divergence on the stochastic indicator.
Another way of trading divergences is using a combination of the regular and the hidden divergence. For this we use the OSMA and CCI indicator. We want to see a hidden divergence on CCI and then a regular divergence on the OSMA.
The stochastic indicator is a very reliable oscillator that shows divergence on the chart. First thing to do is to put the stochastic with 85 and 15 lines. The martingale system is used to manage trades.
When there is hidden divergence on the stochastic and it is below 15, we can either start a buy martingale or wait for the stochastic line to cross the signal line and start buying. Depending on the time frame we are trading we are going to adjust the starting lot size and the gap between trades, the multiplier is constantly set to 2. As for the take profit we can use the value of the gap or higher to the next supply or resistance level on the chart.
Alternatively, when we identify the hidden divergence on a higher time-frame, say 30m or 1H time frame we can go to the 5 or 15 minute time frame to look for a regular divergence for entry.
In summary, divergences are seen everywhere on the charts. And with little training we can see them on any time frame or currency or asset.
Trading with the trend using divergence is a sure way to be consistent for successful results.
When traders say buy at the bottom and sell at the top, what they ought to be saying is “buy at the bottom in an uptrend and sell at the top in a downtrend”, trading using the divergence is a guaranteed way to achieve this type of trading.
When a hidden divergence occurs on the stochastic, go to the higher time frame to confirm that the OSMA is on the side of the trade.
You can trade using the Divergence Trading Strategy with some of our partner brokers.
Trading leveraged products such as Forex and CFDs may not be suitable for all investors as they carry a high degree of risk to your capital. It is important that you do not trade any money that you can’t afford to lose because regardless of how much research you have done, or how confident you are in your trade, there will always be a risk of loss.