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How To Trade Divergences

Now it’s time to put those Jedi-divergence mind tricks to work and force the markets to give you some pips!

Here we’ll show you some examples of when there was divergence between price and oscillator movements.

First up, let’s take a look at regular divergence. Below is a daily chart of USD/CHF.

We can see from the falling trend line that USD/CHF has been in a downtrend. However, there are signs that the downtrend will be coming to an end.

While price has registered lower lows, the stochastic (our indicator of choice) is showing a higher low.

Something smells fishy here. Is the reversal coming to an end? Is it time to buy this sucker?

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Recap About Hidden Divergence

If you’re a trend follower, then you should dedicate some time to spot some hidden divergence.

If you do happen to spot it, it can help you jump in the trend early.

Sounds good, yes?

Okay, now you know about both regular and hidden divergence.

We hope you got it all down pat. Keep in mind that regular divergences are possible signals for trend reversals while hidden divergences signal trend continuation.

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Hidden Divergence

Lastly, we’ve got hidden bearish divergence. This occurs when price makes a lower high (LH), but the oscillator is making a higher high (HH). By now you’ve probably guessed that this occurs in a downtrend. When you see hidden bearish divergence, chances are that the pair will continue to shoot lower and continue the downtrend.

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Hidden Divergence

Divergences not only signal a potential trend reversal; they can also be used as a possible sign for a trend continuation. Always remember, the trend is your friend, so whenever you can get a signal that the trend will continue, then good for you!

Hidden bullish divergence happens when price is making a higher low (HL), but the oscillator is showing a lower low (LL).

This can be seen when the pair is in an uptrend. Once price makes a higher low, look and see if the oscillator does the same. If it doesn’t and makes a lower low, then we’ve got some hidden divergence in our hands.

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Regular Divergence

As you can see from the images above, the regular divergence is best used when trying to pick tops and bottoms. You are looking for an area where price will stop and reverse.

The oscillators signal to us that momentum is starting to shift and even though price has made a higher high (or lower low), chances are that it won’t be sustained.

See the regular bearish divergence at work through this GBP/USD trade handpicked by Pipcrawler!

Did you get all of that? Pretty simple eh?

Now that you’ve got a hold on regular divergence, it’s time to move and learn about the second type of divergence – hidden divergence.

Don’t worry, it’s not super concealed like the Chamber of Secrets and it’s not that tough to spot. The reason it’s called “hidden” is because it’s hiding inside the current trend.

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Regular Divergence

A regular divergence is used as a possible sign for a trend reversal.

If price is making lower lows (LL), but the oscillator is making higher lows (HL), this is considered to be regular bullish divergence.

This normally occurs at the end of a down trend. After establishing a second bottom, if the oscillator fails to make a new low, it is likely that the price will rise, as price and momentum are normally expected to move in line with each other.

The image shows  that portrays regular bullish divergence.

Now, if the price is making a higher high (HH), but the oscillator is lower high (LH), then you have regular bearish divergence.

This type of divergence can be found in an uptrend. After price makes that second high, if the oscillator makes a lower high, then you can probably expect price to reverse and drop.

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Divergence Trading

Higher Highs and Lower Lows

Just think “higher highs” and “lower lows”

Price and momentum normally move hand in hand like Hansel and Gretel, Batman and Robin, Serena and Venus Williams, salt and pepper…You get the point.

If price is making higher highs, the oscillator should also be making higher highs. If price is making lower lows, the oscillator should also be making lower lows.

If they are NOT, that means price and the oscillator are diverging from each other. And that’s why it’s called “divergence.”

Divergence trading is an awesome tool to have in your toolbox because divergences signal to you that something fishy is going on and that you should pay closer attention.

Using divergence trading can be useful in spotting a weakening trend or reversal in momentum. Sometimes you can even use it as a signal for a trend to continue!

There are TWO types of divergence:

-Regular

-Hidden               

In this grade, we will teach you how to spot these divergences and how to trade them. We’ll even have a sweet surprise for you at the end.

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Divergence Trading

What if there was a low risk way to sell near the top or buy near the bottom of a trend?

What if you were already in a long position and you could know ahead of time the perfect place to exit instead of watching your unrealized gains, a.k.a your potential Aston Martin down payment, vanish before your eyes because your trade reverses direction?

What if you believe a currency pair will continue to fall but would like to short at a better price or a less risky entry?

Well guess what? There is a way! It’s called divergence trading.

In a nutshell, divergence can be seen by comparing price action and the movement of an indicator. It doesn’t really matter what indicator you use. You can use RSI, MACD, the stochastic, CCI, etc.

The great thing about divergences is that you can use them as a leading indicator, and after some practice it’s not too difficult to spot.

When traded properly, you can be consistently profitable with divergences. The best thing about divergences is that you’re usually buying near the bottom or selling near the top. This makes the risk on your trades are very small relative to your potential reward.

Cha-ching!

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Summary: Harmonic Price Patterns

The three basic steps in spotting harmonic price patterns are the following

Step 1: Locate a potential harmonic price pattern

Step 2: Measure the potential harmonic price pattern

Step 3: Buy or sell on the completion of the harmonic price pattern

Again, harmonic price patterns are so perfect that they are very difficult to spot.

More than knowing the steps, you need to have hawk-like eyes to spot potential harmonic price patterns and a lot of patience to avoid jumping the gun and entering before the pattern is completed.

With enough practice and experience, trading using harmonic price patterns can yield a lot of pips!

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Summary: Harmonic Price Patterns

Harmonic price patterns enable us to distinguish possible areas for a continuation of the overall trend.

There are six harmonic price patterns:

-The ABCD Pattern

-The Three-Drive Pattern

-The Gartley Pattern

-The Crab Pattern

-The Bat Pattern

-The Butterfly Pattern

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Third Step  in Trading Harmonic Price Patterns

Step 3: Buy or sell on the completion of the Harmonic Price Pattern

Once the pattern is complete, all you have to do is respond appropriately with a buy or sell order.

In this case, you should buy at point D, which is the 1.272 Fibonacci extension of move CB, and put your stop loss a couple of pips below your entry price.

Is it really that easy?

Not exactly.

The problem with harmonic price patterns is that they are so perfect that they are so difficult to spot, kind of like a diamond in the rough.

Check out this excellent forum thread discussing Gartley setups.

More than knowing the steps, you need to have hawk-like eyes to spot potential harmonic price patterns and a lot of patience to avoid jumping the gun and entering before the pattern is completed.

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Second  Step  in Trading Harmonic Price Patterns

Step 2: Measure the potential Harmonic Price Pattern

Using the Fibonacci tool, a pen, and a piece of paper, let us list down our observations.

1.Move BC is .618 retracement of move AB.

2.Move CD is 1.272 extension of move BC.

3.The length of AB is roughly equal to the length of CD.

This pattern qualifies for a bullish ABCD pattern, which is a strong buy signal.

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