Making money with the divergence trading strategy is a dream for many traders. This is because divergence signals can be extremely accurate, and when used correctly, they can produce consistent profits. This blog post will explain what divergence trading is, how to find divergences, and how to profit from them. So if you’re interested in learning more about this powerful trading strategy, keep reading!
Here I will share one of some winning strategy that I have been using on my trading account. This method is simple yet effective, and it may be implemented at any moment based on your availability. This strategy needs a name, let’s call this Divergence Trading Strategy because the main signal of the strategy is using divergence in price.
What is Divergence in Trading?
Divergence is when the price of a trading instrument is moving in the opposite direction of a technical indicator, such as an oscillator, or is moving contrary to other data. Divergence warns that the current price trend may be reversing, or in some cases may lead to the price continuing the trend. When the price movement is not in agreement with the technical indicator, it is called a divergence.
See the table below for an example:
If you’re new to divergence trading, you should save this image as a reference.
REGULAR DIVERGENCE
When the price makes a new higher top but the technical indicator makes a new lower top, it indicates a price reversal and vice versa for the opposite condition.
HIDDEN DIVERGENCE
When price is making a new lower top but the technical indicator make a new higher top instead then it is indicating a trend continuation and the other way around for the opposite condition.
EXAGGERATED DIVERGENCE
When the price makes a double top but the technical indicator makes a new lower top instead, it indicates a strong price reversal and vice versa for the opposite condition.
If the above cheat sheet still got you confused, then you must read our page Trading Divergence for a better understanding on how Divergence in Trading works or else you will be more confused with what you will read next.
However, if you’ve figured out how the divergence works so far, keep reading.
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How to Trade Divergence
Now that you know what divergence trading is and how to find divergences, it’s time to learn how to trade them profitably. Here are some pointers to get you started:
1. Wait for a confirmed divergence signal. Because a divergence signal isn’t always correct, it’s critical to wait for confirmation before entering a trade. This confirmation can come in the form of a breakout or other indicator signal.
2. Enter a trade in the trend’s direction. When trading divergence occurs, it is critical to always enter trades in the direction of the trend. This will assist you raise your chances of success while decreasing your risk.
3. Use small stop losses. Because divergence signals can be quite accurate, it’s important to use tight stop losses when trading them. If the trade goes against you, this will help to limit your losses.
4. Take profit at key levels. When trading divergence, it’s also important to take profits at key levels. If the trade goes against you, this will help you lock in profits and minimize losses.
Now that you’ve grasped the idea of trading the divergence, it’s time to put it into practice in real-world trading scenarios. Continue reading.
Indicators to Use to Find Divergence
This indicator is provided by Scriptor and is available for download at mql5.com.
Essentially, any type of Oscillator can be used as a technical indicator to determine divergence from price movements. Some traders employ RSI, Stochastic, MacD, and other indicators. Nothing is wrong with finding divergence using those indicators, they will all work well in doing the job.
My personal favorite is the OsMA indicator. Pretty accurate, and simple to read and apply. There’s an indicator already made for MT4 that can detect the divergence as it happens on your chart so you don’t have to look for one.
Consider the following example:
I attached the divergence indicator on to 15 minute chart using default settings on November 22nd, 2022, as you can see it was able to indicate the divergence between the price and the indicator. On that day, there were four trading opportunities that could be taken advantage of to make a decent profit.
The first divergence was the price made a new higher top but the indicator a new lower top instead, contributed to a SELL signal.
The second divergence occurred when the price made a new higher bottom but the indicator made a new lower bottom, resulting in a BUY signal.
The third divergence occurred when the price made a new higher top but the indicator made a new lower top, resulting in a SELL signal.
The fourth divergence was the price created a new higher bottom but the indicator formed a new lower bottom instead, led to a BUY signal.
Nevertheless, as you can see the signals are not very accurate. I mean look at that, the first divergence only made you few pips before price reverses and probably hit your Stop Loss level, the second one however was profitable, but the third one again made you a loss, although the fourth one was also profitable.
Considering the above, we learned that we cannot trade the divergence indicator alone, but must use the second indicator to filter the signals produced by the divergence indicator. What indicator do we use to filter the misleading divergence signal then?
All Pivot Point Indicator
This indicator is courtesy of Hossein Nouri and can be downloaded at mql5.com
You may use many other indicators as filter, but my fave is this one, utilize pivot point based on fibonacci that is derived on the daily chart of the previous day.
Remember point 2 of How To Trade the Divergence article? You must enter the trade in the opposite direction of the trend. You will only trade the divergence signal to the trend direction with All Pivot Point Indicator.
Now let’s put this filter on to our chart and see how it might filter losing trades from winning ones:
That sounds more like it. The All Pivot Point indicator calculated that the price was above the fibonacci pivot point on that day, indicating that we should only be looking to BUY rather than SELL for the day. When price is above pivot point, any SELL signal generated by the Divergence indicator should be ignored. This left us with only 2 trades for that day, and both trades were winning.
The first SELL signal from the divergence indicator was ignored because it occurred above the fibonacci pivot point, and it was a good call because we would have lost it if we had taken it.
The second BUY signal by the divergence indicator came above fibonacci pivot point right on the first resistance level, we joined the trade with Take Profit level at the 2nd resistance level, which was hit for a wonderful 52 pips.
The third SELL signal from the divergence indicator was ignored since it occur above fibonacci pivot point.
The fourth BUY signal from the divergence indicator was above the fibonacci pivot point, indicating that the trade was valid, and the Stop Loss should be placed 5 pips below the previous lowest low.
Conclusion
That’s all there is to it! Trading strategy does not have to be complicated; rather, it should be basic but effective. The trick is to be consistent. The difficulty is in staring at the chart and waiting for the signal to line up before acting.
Some traders opt to trade using low time frame like 1 minute or 5 minute but only trading 2 hours a day during high volatility like London Market open or US session, there are a lot of signals there. However, some traders believe that the low time frame is too rapid, and if they want to trade in a more relaxed manner, they might trade the 1 hour chart instead.
There’s no right or wrong in relation to at what time frame one can employ this trading method, it is all relies on what type of trader you are. The key line is this method works on all time frame.
Notes: If you want to trade the 15 minute, 30 minute, or 1 hour minute charts, you must configure the All Pivot Point indicator to compute pivots on the daily chart. You can set the All Pivot Point indicator to compute pivots based on the 1 hour chart for shorter time frames such as 1 minute or 5 minute charts. This is simply adjustable within the indicator’s parameters.
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