Divergence Patterns-Instant Profit

Divergence is a Trading Strategy widely used in Forex Trading. When visible on the charts you will not miss some PIPS.

When trading Forex (and the Financial Markets in General), many traders use different indicators in order to get additional confirmation for their signals. The primary indicator that a trader should use is Price itself, because Price action will provide you the clearest picture and get your closest to what’s happening in the market at any given time. Having said that, there are times when you should combine price action analysis with traditional technical indicators. Typically, you would look for clues between the indicator and price action in order to make a decision. One of the most powerful trading signals that combines price action analysis with the use of indicators is the Divergence signal, and that’s what we intend to discuss in this lesson.

Divergence Trading Patterns

The name of this pattern speaks of its character. We have a divergence when the price movement is contrary to the indicator movement. This type of Regular Divergence pattern comes in two forms:

Bearish Divergence

This is when price creates higher tops on the chart, while your indicator is giving you lower tops. After a bearish divergence, price usually makes a rapid bearish move. Notice that this happens despite the previous bullish attitude in the price.

Bullish Divergence

The bullish divergence has absolutely the same characteristics as the bearish divergence, but in the opposite direction. We have a bullish divergence when the price makes lower bottoms on the chart, while your indicator is giving you higher bottoms. After a bullish divergence pattern, we are likely to see a rapid price increase.

However, there is a third kind of a divergence, which does not fall into the regular divergence group. This is the Hidden Divergence pattern.

Hidden Bullish Divergence

We have a hidden bullish divergence when the price has higher bottoms on the chart, while the indicator is showing lower bottoms.

Hidden Bearish Divergence

As you probably guess, this type of divergence has the same character as the hidden bullish divergence, but in the opposite direction. We confirm a hidden bearish divergence when the price is showing lower tops, and the indicator gives higher tops.

The regular divergence pattern is used to forecast an upcoming price reversal. When you spot a regular bullish divergence, you expect the price to cancel its bearish move and to switch to an upward move. When you see a regular bearish divergence, you expect the price to cancel its bullish move and switch to a downward move.

Divergence trading is an extremely effective way to trade Forex. The reason for this is divergence formations are a leading signal. This means that the divergence pattern is likely to occur before the actual move. This way, traders are able to anticipate and enter a trade right at the beginning of the new emerging move.

Relative Strength Index (RSI)

The Relative Strength Index is another good indicator to build a successful Forex divergence system. The primary function of this indicator is to discover overbought/oversold price conditions.

The RSI indicator consists of a single line, which moves between an overbought and oversold zone. In this manner, the RSI has a leading character. It is an oscillator like the Stochastic. Therefore, it is a good tool for spotting divergences on your chart.

When you find a mismatch between price action’s tops or bottoms and RSI’s tops or bottoms, you have a divergence pattern forming. If you spot the pattern, it will provide for an early entry signal for your trade.

The image below will show you how to trade divergence with the RSI indicator.

This is the H4 chart of the GBP/USD. At the bottom of the chart you see the Relative Strength Index indicator. The chart shows lower bottoms, while the RSI shows higher bottoms. This means that we have a confirmed bullish divergence on the chart, which provides an opportunity for a long trade on the GBP/USD Forex pair.

Conclusion

1. A divergence setup is a leading Forex pattern, giving us an early entry into emerging price moves.

2. Divergence trading is an effective method, and allow traders to combine price action and indicator analysis into a trading strategy

3. There are four types of divergence patterns:

   • Regular Bullish Divergence

   • Regular Bearish Divergence

   • Hidden Bullish Divergence

   • Hidden Bearish Divergence

4. Some reliable indicators for trading Forex divergence are:

• MACD

• RSI

• Stochastic Oscillator

• Momentum and Bollinger Bands

5. A sound money management plan is required for trading Forex divergence or any strategy for that matter.