Trading Divergences Can Be Highly Profitable!

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Published: 13th January 2011
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Divergences are considered to be an important arsenal in the trading toolkit of a pro trader. Divergence happens when price moves in one direction and the indicator moves in the opposite direction.

Now any oscillator can be used to show divergence patterns. The most commonly used oscillators include RSI, Stochastics, MACD, CCI, ROC and Williams %R. However, any oscillator can show divergence with price action.

Divergence can be regular or hidden. Regular divergence can be bullish or bearish.

In case of Bullish Regular Divergence prices make a lower low while the oscillator makes a higher low whereas in case of Bearish Regular Divergence price makes a higher high while the oscillator makes a lower high.

When this regular divergence pattern appears on the chart it means that the price action is losing its momentum which in turn means a potential trend reversal or consolidation. When you spot a regular divergence pattern appearing on the chart, you should not ignore it as it is a warning that a potential trend reversal can take place.

The case of hidden divergence is the exact opposite of the regular divergence. Hidden divergence tells of the trend continuation. There are two type of hidden divergences, bearish and bullish.

In case of the Bearish Hidden Divergence, price action makes a lower high while the oscillator makes a higher high. While in case of the Bullish Hidden Divergence, price action makes a higher low while the oscillator makes a lower low. In a bearish hidden divergence price is in a downtrend. Appearance of the bearish hidden divergence pattern means continuation of the downtrend.

In the same manner, when the oscillator diverges from the prices in an uptrend in a bullish hidden divergence pattern, it means continuation of the uptrend. Some traders believe that the hidden divergence pattern is a far more trading signal than a regular divergence.

You can use a Divergence Pattern Recognizer Indicator to identify these divergence patterns. However, these patterns only confirm trend reversal or trend continuation. You will still need indicators to make entry and exit into a trade.


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