How To Trade Divergence In Forex – The Hidden Secret
Trading with divergence in form can be really tricky. There are many reasons for it. For instance, it is quite easy to make the mistake of going on a buying and selling spree in the hope that it will bring you good returns. Unfortunately, this is not a strategy that bears any fruit. In fact, it can lead to huge losses. Let us see why this happens.
Trading with trendlines in order to follow the market price divergence is possible but not advisable. There are three reasons for this. First, the price of a currency pair does not follow a single trend. It has a tendency to follow a “jumping” pattern called a Trendline.
If we look at the basic formula of trading forex, we see that there are three conditions that need to be satisfied. The first one is the distance between two points on a line. Second, there should be a constant upward or downward pressure exerted on said points. And third, a constant force must push the market price up or down.
These conditions simply mean that there is no such thing as a perfect moving average. Divergence in the price charts is unavoidable, so what we need is a reliable moving average (SMA) or combined MA. With a combination of an SMA and a divergence signal, we can eliminate most of the false signals from the market and concentrate on those charts that are truly useful in interpreting the market data.
Let’s take a look at a very simple moving average. It is called the doubling tops chart. It is simple to understand. The red trend line has a break above the blue line. When this trend line is crossed by the red line, we know that there is a high possibility for a doubling tops in the immediate future.
But how does this information affect our trade strategy? Since a doubling tops chart displays high probability for price highs, it tells us that we should expect price highs to continue rising. This can either confirm our buy or sell signals, depending on which way the indicator highs point. If we were to follow the simple rule that says that the higher price highs indicate a higher chance for a successful trade, then the doubling tops would definitely confirm our buy trigger. Since a high moving average gives us another indicator to work with, we can now make better trade decisions based on the indicators and not just on the simple moving average that indicate the direction of the market.
On the contrary, a bearish divergence in the price charts means that there is a decreasing chance for a price highs. A bearish divergence, therefore, tells us that the current market is going down and we should watch out for the down trend. In order to keep safe from a bearish divergence, we have to follow a long-term upward trend. Conversely, if the market is on an uptrend, the blue lines indicate that the uptrend is about to turn bearish and we should look to take profit before the uptrend reverses.
In general, the longer the up trend, the bigger the divergence. Thus, a bearish entry point usually means a smaller amount of gains than with a bullish entry point. How to Trade Divergence in Forex requires more accurate signals than these basic rules. The best way to learn how to trade divergence in Forex is to use technical analysis tools such as an indicator review, candle stick and support levels.
Sometimes, a bullish divergence can continue to build up until the price highs turn bearish. If this happens, we have entered into a bear market and we should look to ride out the down trend. Here, the uptrend would resume and the price tops may go up even in the face of a bear market. How to Trade Divergence in Forex is very important in such circumstances? Traders have to be very alert and they must focus on the difference between higher highs and lower lows.
When you use divergence trading forex strategies, you have to be very observant to detect hidden divergences. There are several types of divergence signals that can be used by traders. For instance, the upward divergence is more common when the price moves up but fails to break through the resistance line. This can be detected easily using a candlestick or a line graph.
The extended bearish divergence has a very high false positive rate. Such a signal alerts investors when the prices are overbought or oversold. Such a signal usually becomes profitable in very short term only when the pattern is valid and the price has passed through the overbought and oversold conditions. In addition, a longer period than the traditional high and low bands can also be used as a signal. When this happens, a trend reversal is possible and we can take profit.