How To Trade A Divergence – A Step By Step Trading Guide

I only trade divergence after a trend has formed. The one thing you should be concerned about is the level of volatility a stock or futures contract exhibits. Learning how to trade RSI divergence can be tricky. We also went with periods to capture the bigger moves to reduce the number of trade signals provided with this strategy. I agree that combining the two is a great strategy. We exit the market right after the trigger line breaks the MACD in the opposite direction. After a 6-day decrease, the two MACD lines create a higher bottom, while the price action is still decreasing.

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Price and indicator are out of sync. The RSI compares the average gain and the average loss over a certain period. So for example, if your RSI is set to 14, it compares the bullish candles and the bearish candles over the past 14 candles. When the RSI value is low, it means that there were more and stronger bearish candles than bullish candles over the past 14 candles; and when the RSI is high it means that there were more and larger bullish candles over the past 14 candles.

Understanding when your indicator is high or low is important when it comes to interpreting divergences and I generally encourage traders to look beyond the squiggly lines of their indicators to explore what it really does. During trends, you can use the RSI the compare the individual trend waves and so get a feeling for the strength of the trend.

Here are the three scenarios and the screenshot below shows every single one:. This means that there were more and larger bullish candles in the most recent trend wave than there were compared to the previous wave.

When the RSI makes an equal high, it does not qualify as a divergence because it just means that the strength of the uptrend is still up and stable. Higher highs on the RSI do not show a reversal or weakness.

It just means that the trend is progressing unchanged. This is what we call a divergence and in the screenshot below, the divergence signaled the end of the uptrend and it makes a downtrend possible.

Classic technical analysis tells us that a trend exists when price makes a higher high — but like too often, conventional wisdom is seldom right and usually simplifies things too much. A trader who only relies on highs and lows for his price analysis often misses important clues and does not fully understand market dynamics. Spotting a divergence on your momentum indicator, thus, tells you that the dynamics in the trend are shifting and that, although it could still look like a real trend, a potential end of the trend could be near.

I am a pure reversal trader and early-trend trades after divergences are my bread and butter trades. A divergence does not always lead to a strong reversal and often price just enters a sideways consolidation after a divergence.

Keep in mind that a divergence just signals a loss of momentum, but does not necessarily signal a complete trend shift. A divergence alone is not something that strong enough and many traders experience bad results when trading only with divergences. Just like any trading strategy, you need to add more confluence factors to make your strategy strong.

Below we see how price made 2 divergences but price never sold off. The divergences, thus, just highlighted short-term consolidation. Location is a universal concept in trading and regardless of your trading system, adding the filter of location can usually always enhance the quality of your signals and trades. You missed the boat this time.

Divergence signals tend to be more accurate on the longer time frames. You get less false signals. This means fewer trades but if you structure your trade well, then your profit potential can be huge.

Divergences on shorter time frames will occur more frequently but are less reliable. We advise only look for divergences on 1-hour charts or longer. Other traders use minute charts or even faster. So there you have it kiddos — 9 rules you MUST follow if you want to seriously consider trading using divergences. Your account will take more hits than BabyPips. Follow these rules, and you will dramatically increase the chances of a divergence setup leading to a profitable trade.

Now go scan the charts and see if you can spot some divergences that happened in the past as a great way to begin getting your divergence skills up to par!

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Strategy Set-Up

Divergence trading strategy requires you to pay attention not just to the indicator, but also to price itself. This is why it is a better way to use oscillators. We should never use trading . Two Roads Diverged: Trading Divergences (e-book) Catching reversals (false breakout with a divergence) An end-of-day trend-following system (by Kerry Lovvorn) This book, Step by Step Trading, will walk you through the essentials of this fantastically interesting but demanding craft and teach you its main do’s and. Would you like to know how to trade divergence like a pro? Learn these powerful MACD, stochastic, or RSI divergence trading strategies. Learning a divergence trading strategy that works should be a top priority for any technical trader.