Divergences: trading strategies

How do we use divergences in our trading?

Divergences are a widely used trading strategy for many traders today. There are many technical indicators (they are mathematical relationships that are represented graphically), however none of them really work on their own. It is important not to lose sight of the fact that they are still information derived from the movement of the price and their fundamental utility lies in helping us make the information more visual or in simplifying its analysis, but they do not provide us with extra information.

Although we are not going to use indicators to determine where to take positions in the market, we can take into account the divergences, whether bullish or bearish, of support in the analysis of the market situation that we have in our long-term chart (never in long-term horizons). minor temporary).

To study bullish or bearish divergences in trading, some of the following indicators are often used: MACD, Stochastic, Momentum, On balance volume, CCI, CHAIKIN oscillator. Among them, the most frequently used for the study of divergences are:

· The CHAIKIN oscillator which is a volume based oscillator.

The MACD indicator

·On ​​Balance Volume indicator.

So let’s look at our long-term chart to get a first idea of ​​whether the market we’re looking at is in a long-term uptrend, downtrend, or sideways trend. For this we can help ourselves, for example, with the MACD technical indicator, one of the indicators mentioned above.

The divergences between price and oscillator allow us to estimate trend exhaustion zones and possible price reversal. Divergence occurs when successive lows are observed in the price at the same time as successive highs are observed in the indicator (bullish divergence) and vice versa (bearish divergence).

This element, together with the study of price exhaustion patterns, will provide us with a vision of how the price is moving and when a trend is about to end.

The problem associated with divergences is that, although they indicate some weakness in the current trend, they do not tell us when that trend change (or continuation, depending on the type) is going to occur. Therefore, once a divergence has been recognized, if we decide to trade based on it, it is important to set a stop loss to control losses in case the trade turns against it. If you are in a trade that is doing well for you and spot a divergence, adjust your stop loss or exit the trade, saving your capital gains. If you are outside a stock you like and spot a divergence in your favor

Types of divergences with MACD

In trading and the stock market there are several types of divergences that we can observe. We are going to look at the bullish and bearish trading divergences that we can look for using the MACD technical indicator. In our basic trading course, professional trading course and Trader’s Launch course you can learn many more divergences in other technical indicators and how we use them to make money trading on the stock market.

Bullish divergences: They occur when the lows of the indicator are getting higher and the price is making lower lows.

Next we have a divergence, we see that the MACD makes a lower low than the previous one while the price falls considerably in relation to its last low.

bearish divergences: They occur when the opposite of the previous case occurs. The maximums of the indicator are usually lower and lower and on the contrary the prices of the asset are higher and higher.

Next we have a bearish divergence, the price makes a new high while the MACD fails to break above its previous high Divergences have no validity for some while they are a very reliable tool for others. This dilemma is very common both in forex and in other financial markets. It is up to you to build your own opinion after a period of trial and practice with the differences. From my point of view, trading with divergences has proven to be reliable quite often, at least in forex and long timeframes: take a daily chart of any currency pair and you can see numerous divergences that have paid off. Do an analysis of the highs and lows of the prices, the upward and downward trends that they present, and the divergence that these present in the indicators that I explained to you before.

As a final advice, I recommend that before trying any new trading and stock market strategy you do it on a demo account, that you seek training to help you place stop losses in this type of divergence trading and that you measure your results with a trading journal.

Sounds interesting to you, right? Keep learning trading with DTP with upcoming articles on our Blog.

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