Divergences in trading - definition & explanation

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This happens when the price of an asset or index reaches a higher high but the indicator you are using has a lower high, usually the MACD indicator. This means that if your indicator and the price movement are out of sync, this is a sign that something is happening in your chart.

Traders are known to make decisions based on situations where divergences occur. Since it can be either positive or negative, either direction means a big shift in the direction of the price.

What you need to know is that a positive (bullish) divergence occurs only when the security price moves down while the indicator starts to rise. This indicates weakness in the downtrend.

On the other hand, negative (bearish) divergence occurs when the security price rises to a new high while the indicator does not reach the same momentum. This indicates weakness in the uptrend.

As a result, it helps traders to identify and react to the changes caused by price actions. Traders can make one of the following decisions:

  •     Tighten the stop loss
  •     Take profits because the situation improves profitability as traders are warned to protect their profits

How to trade divergence - rules you need to follow

You will notice that the blue average line between the peaks is moving up, while the MACD below it has a lower high, indicating a divergence and a change in momentum.

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1. price scenarios

As a trader, you should know that for a divergence to exist, the price must have formed in one of the following situations: Lower low than previous low, Higher high than previous high, Double top or Double bottom.

If none of the following indicators occurred, your situation cannot be called a divergence.

2. focus your attention on the price

When identifying divergences, it is common practice to connect the top and bottom with a trend line. When it comes to analysis, you need to look at your indicator and make a comparison with the price action.

Regardless of which indicator is used, it is important to keep in mind that you are comparing it to the upside and downside. Commonly used indicators in Thailand Exness are MACD, volume or stochastic.

3. slopes must be different

When you draw a trend line between the tops and bottoms, you get a slope. For a divergence to exist, the slope of the line connecting your indicator tops or bottoms must be different from the slope of the trend line connecting the price tops or bottoms.

This means that the slope must be either ascending or descending.

4. never follow it

Experienced traders are known to watch oscillators such as RSI, CCI and Stochastic. Since trends consist of a series of price swings, price momentum plays a crucial role in judging the strength of the trend.

Therefore, it is important to know when a trend is forming. It is also critical to keep in mind that lower momentum may not lead to a reversal, but may signal a shift. As a trader, if you miss the opportunity, don't chase the movement. Wait for another swing and begin your search.

Be cautious

Experience has shown that divergence signals are more accurate when longer time frames are involved. This leads to fewer trades. One thing you should know is that a well-structured strategy will increase your chances of winning. Shorter time frames do occur, and as a result, they occur frequently, but they are not reliable.

If you want to trade divergence successfully, look for it on 1-hour charts or longer. There are day traders who use 15-minute charts, but this type of time frame creates too much noise and would lead to waste. Stay away from them!

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