How to Trade Divergence in Forex and Avoid Common Mistakes

By | August 8, 2022

Trading Divergences in Forex

The very concept of divergence means the discrepancy between the readings of two or more correlated data sources.

Imagine that you are sitting in the cockpit of an airplane, and all of a sudden the instruments start indicating that you are declining sharply. At the same time, it is clearly outside the window, and you see that everything is in order with the plane. This is divergence.

*Don’t be afraid, the plane has successfully landed*

In trading, divergence is a mismatch between price peaks/troughs and indicator peaks/troughs.

What is a divergence in trading?

In most cases, the divergence appears on swinging indicators (those that “swing” around the midline). These are indicators like MACD, RSI, Stochastic, CCI, etc.

However, the divergence also shows up in volume indicators. It has more weight than technical indicators. But the same principles of divergence trading are the same for all indicators. The appearance of divergence tells us that the price is preparing for a investment or that the current impulse has worked.

The first thing to remember is that divergence itself should not be a signal to get into The market. You should have the main signal, and the divergence will act as a confirmation of this sign.

This must be done in accordance with all the canons of technical analysis. But in practice, it is not easy to talk about the effectiveness of divergence. Like other technical indicators, it is based on price, so it does not differ much from them in terms of performance. By the way, the ratio of traders’ positions can also be called divergence. After all, this is also a discrepancy when the majority is buying and the price goes down.

Forex Divergence Types Explained

It should be noted that there could be different examples of divergence in Forex. To enter more into the market precisely, you need to see and distinguish the types of Forex divergences in different time periods. Let’s consider each type separately.

regular divergence

Regular divergence allows you to see a trend reversal. This is a good signal to either sell short or buy long. If the divergence is bearish, the price chart will prepare for a bearish move. Forex traders must prepare to sell. When there is a bullish divergence, it is worth getting ready to buy as the chart will go higher. By the way, examples of divergence on Forex can be different. The main thing is to correctly determine its type using the oscillator.

regular bearish divergence

To identify a bearish divergence in the market, a trader must look at the price highs (the shadows of the Forex candlesticks) and the corresponding indicator. A classic bearish divergence will occur when certain conditions are met: a high should appear on the price chart, the indicator should show a lower high.

However, it is not necessary to observe higher maximum price values ​​on the chart. It is enough that the previous peak is slightly lower than the next.

regular bearish divergence

regular bullish divergence

To determine the classic Forex bullish divergence, you need to pay attention to the lows of the chart, as well as the indicator. If the market has a regular bullish divergence, then the candlesticks will draw a lower price value and the indicator, on the contrary, will draw a higher low.. In this case, we should expect a bullish move; that is, the trader needs to prepare to buy.

regular bullish divergence

How to trade regular divergence?

You should use any trend indicator like the moving average to learn the main trend and get confirmation of the divergence to enter a trade. For example, you can use 20, a period simple moving average. If you find a bullish divergence and the price is above the 20 SMA, then you enter the long position. You can place the stop loss slightly below the recent low, while the take profit can be placed near the next resistance level.

How to Trade Regular Divergence - Divergence Forex

extended divergences

Forex extended divergence is somewhat similar to the usual classic divergence. But in the case of an extended divergence, the price forms a pattern that looks a lot like a “false bottom” or “double top”.

Everything is clear with graphic figures, but how to determine the direction of the market if the indicators draw a second minimum or maximum, which are very different from the minimum or maximum prices in the terminal? If this feature is observed, the price will continue to go in the same direction.

Extended divergence is of two types:

It is important to note that Forex extended divergence is one of the varieties of trend divergence in its classical sense. It can be seen when the market intends to slow down, but instead of changing direction, it continues to move in the same direction it was before.

extended bearish divergence

If there is an extended bearish divergence on the chart, it can only mean one thing; prices will continue to drop, so you need to look for a selling opportunity.

To determine the extended bearish divergence, the trader must pay attention to the spikes (highs) not only on the chart but also on the indicator. Usually, this type of divergence is seen along the top during a big move. The market draws a double top, but the second price peak may be slightly higher or lower than the previous value. Even if the upper levels are the same, the indicator will show a second lower high. The indicator will not draw the double top seen on the price chart.

You can solve this problem in another way. You don’t have to think about how to see the divergence. Suppose the price chart draws a double bottom or top, and the indicator does not repeat the pattern formation like the market, but shows a misalignment. In that case, this should be considered the formation of an extended bearish or bullish divergence.

extended bearish divergence

extended bullish divergence

If the chart shows extended bullish divergence, you should look for a buying opportunity as prices rise.

In order to recognize a long bullish divergence in the terminal, it is necessary first of all to pay attention to the bottom or lows of not only the price but also the basement indicator. Usually, during a prolonged bullish divergence, the prices draw a double bottom.

Although the lows on the chart will show up at roughly the same level, the indicator will show a slightly different picture; the second minimum will be significantly higher than the first. If this condition is met, it means that we are facing an extended bullish divergence in Forex, and the trader should look for profitable moments to buy.

Extended Bullish Divergence - Forex Divergence

How to trade extended divergence?

If you see extended divergence on the chart, take confirmation from any other indicator. If other indicators confirm the trend change, enter the trade with a stop loss at a recent low/high with the profit target at the next support/resistance level.

How to trade extended divergence

hidden divergence in forex

In Forex, Forex hidden divergence informs about the continuation of the trend. However, it is quite difficult to recognize it in a trading terminal. Forex hidden divergence gives a clear signal to open a buy or sell position.

If there is a hidden bearish divergence in the market, the price chart can be expected to continue its downward movement. When there is a hidden bullish divergence on the chart, the price will go up.

hidden bearish divergence

To see hidden bearish divergence in Forex, you need to identify the candlesticks’ tops or price highs, as well as the indicator. The MACD indicator can be used to identify hidden divergences. This scenario arises only when the price goes down. If the indicator shows a divergence right now, a move lower can be expected in the future.

hidden bearish divergence

hidden bullish divergence

To spot a hidden bullish divergence, you need to pay attention to the lows on the chart as well as the indicator. This type of divergence occurs when the market is rising, drawing high lows, and the indicator reads lower.

Hidden Bullish Divergence - Forex Divergence

How to trade a hidden divergence?

If you see a hidden divergence, simply enter the trade with a stop loss around the recent swing low/high with a profit target near the next support/resistance level.

How to Trade a Hidden Divergence - Divergence Forex

Common mistakes when trading divergences

Most traders see divergences on the chart and just enter the trade without thinking for a moment longer. The need is to filter out the false signals and find a high probability trade setup. Therefore, do not enter the trade impulsively, rather wait for a brief pullback and then enter. Also, you can avoid a bad trade by following the candles. For example, if you see a bullish divergence, wait for a bullish candle to appear and then enter. Do not enter a trade if there is a long wick at the top of the candle.

What are the best indicators using Divergence??

You can find divergence with any oscillator indicator. However, the results vary depending on the currency pairs and the chosen indicator. Among all, we have shortlisted the top three oscillator indicators that can be very helpful in your trading.

MACD indicator

The MACD indicator can be very beneficial to find the divergence and spot an early trend reversal in coins. You can use the default settings of the indicator at any time frame. However, it is better to use a 1 hour time frame. You can use Take Profit and Stop Loss with a fixed difference of 20 pips or you can also use support and resistance levels.

Commodity Channel Index

The CCI indicator is another good option to determine the divergence. It can be applied at any time period with the default settings. However, it is recommended to use time frames of 15 minutes, 30 minutes and 1 hour. You can use oversold and overbought conditions to exit trades.

stochastic

The stochastic is a widely used indicator for divergence. The recommended time frame is 1 hour, while the indicator can be used to exit trades based on overbought and oversold conditions.

forex divergence summary

Divergence is a means to find the early trend reversal signal. There can be three types of divergence i.e. Regular, Extended and Hidden. You can use MACD, CCI, Stochastic or any other oscillator to find the divergence. You should use any confirmation signals to add more chance of success to your trading.

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