Divergence is one of the most efficient trading concepts that offer reliable high-quality trading signals. The most curious thing is that it owes its accuracy to the lagging action of oscillators.
Divergences are a big part of many traders’ strategies. Some use them to identify beneficial entry points, others to choose a proper time for exiting their positions. In this tutorial, we will tell you how to spot and trade these cross-functional trading patterns.
Divergence: definition
Let’s start with identifying what is a divergence. Basically, divergence means that the price chart and the technical indicator (oscillator) you use for analyzing the market goes in opposite directions. It is the first signal for you to understand that “something” is happening on your chart.
A bearish divergence occurs when the price creates higher highs on the chart, while your indicator makes lower highs. After such bearish divergence prices normally move downwards: the price needs to catch up with the lower indicator.
A bullish divergence (also called “convergence”) occurs when the prices create lower lows on the chart, while your indicator shows higher lows. That is the first indication that prices are going to pick up soon: the price needs to catch up with the higher indicator.
Note that when we talk about bearish divergences we are looking at highs at the price chart. When we talking about bullish divergences, we are talking about lows.
In addition to classic divergences, there are so-called hidden divergences.
A hidden bearish divergence occurs when the price creates lower highs on the chart, while your indicator makes higher highs. The absence of new highs on the price chart shows that bulls are losing strength. Despite the higher high of the oscillator the movement up is likely a retracement. This movement represents an opportunity to sell at higher levels.
A hidden bullish divergence occurs when the price creates higher lows on the chart, while your indicator makes lower lows. The absence of new lows on the price chart shows that bears are losing strength. Despite the lower low of the oscillator the movement down is likely a retracement. This movement represents an opportunity to buy at lower levels.
Experience shows that it’s easier to spot classic divergences than the hidden ones.
Type
Price
Oscillator
Description and Trading
Classic: expect reversal
Bearish
Higher High
Lower High
Potential reversal to the downside
Bullish
Lower Low
Higher Low
Potential reversal to the upside
Hidden: expect correction and continuation
Bearish
Lower High
Higher High
Downtrend will likely resume
Bullish
Higher Low
Lower Low
Uptrend will likely resume
Divergences are normally used for forecasting price corrections and reversals. They are likely to occur before the actual price action. That is something that makes them so effective and allows traders to enter a trade right at the very beginning of the new emerging price move.
Regardless of the indicator you choose, we recommend you to always place Stop Loss orders before making your trading bets. It is no different when you trade divergences. You may put a Stop Loss above the last top on the chart which confirms the occurrence of bearish divergence. If the divergence you are dealing with is bullish, you should place a Stop Loss below the last bottom on the chart.
To find a place for a Take Profit order you will probably need an additional indicator (especially if you trade with RSI and Stochastic). You may use swing analysis or support/resistance levels for setting Take Profit. However, if you prefer using MACD while trading divergences, then you could fully rely on this indicator alone without any supplementary trading tools. When MACD histogram crosses the signal line upside down, it’s a signal to close bullish position. When MACD histogram crosses the signal line bottom up, it’s a signal to close bearish position.
Here is an example of divergence trade with MACD oscillator.
Suppose you found a bullish divergence (convergence) between the MACD and the price chart. In addition, you notice a bullish crossover in the MACD window. You use this price divergence as a signal to open a long position. A Stop Loss order should be placed below the last bottom of the price. Close your trade when the bearish crossover on the MACD oscillator is formed.
Divergence: great signal for your trades
Many traders build strategies based on divergences and identify entry and exit points. During this webinar, FBS analyst Ekaterina Gorbatenko will explain to you:
How to divide a bearish divergence from a bullish one;
What are the perfect signals a divergence can give you;
Click the ‘Open account’ button on our website and proceed to the Personal Area. Before you can start trading, pass a profile verification. Confirm your email and phone number, get your ID verified. This procedure guarantees the safety of your funds and identity. Once you are done with all the checks, go to the preferred trading platform, and start trading.
How to withdraw the money you earned with FBS?
The procedure is very straightforward. Go to the Withdrawal page on the website or the Finances section of the FBS Personal Area and access Withdrawal. You can get the earned money via the same payment system that you used for depositing. In case you funded the account via various methods, withdraw your profit via the same methods in the ratio according to the deposited sums.
How to start trading?
If you are 18+ years old, you can join FBS and begin your FX journey. To trade, you need a brokerage account and sufficient knowledge on how assets behave in the financial markets. Start with studying the basics with our free educational materials and creating an FBS account. You may want to test the environment with virtual money with a Demo account. Once you are ready, enter the real market and trade to succeed.
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