An error occurred submitting your form. However, the first one completely failed and the second one resulted in a massive winner.
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In this case, the correction in price would need to have been a directional change to the upside. That is exactly what happened. Like clockwork, as evidenced by the chart above, price turned up in early December and did not look back until the second divergence was completed. This first divergence signal was so strong that there was even a mini divergence shown in Figure 1 with dark red dotted lines within the larger divergence that helped to confirm the signal to go long.
Luckily, some of the subsequent bull run was caught as a result of spotting this very clear divergence signal early on. Anyone who caught this particular divergence play was richly rewarded with almost immediate profit gratification.
Below, we will explain the method I used to trade it. The Trade The second divergence signal seen in dark blue , which occurred between mid-December and mid-January , was not quite a textbook signal. While it is true that the contrast between the two peaks on the MACD histogram's lower high was extremely prominent, the action on price was not so much a straightforward higher high as it was just one continuous uptrend.
In other words, the price portion of this second divergence did not have a delineation that was nearly as good in its peaks as the first divergence had in its clear-cut troughs. For related reading, see Peak-and-Trough Analysis. Whether or not this imperfection in the signal was responsible for the less-than-stellar results that immediately ensued is difficult to say.
It is an age old concept that was developed by Charles Dow and mentioned in his Dow Tenets. Dow noticed that when the Dow Jones Industrials made new highs, the Dow Transportation Index tends to make new highs as well and when the Industrials index made new lows, the transportation index would also follow suit.
This is because when industrial production is high, transportation is used more to ship the goods. During times of recession or slowdown, when production dropped, the transportation would also drop. The most important of all is when Dow found out that when there was a divergence between the two, it presented a possible change in the markets.
For example, when the Dow Industrials made new highs and when the transportation index failed to make a high it indicated that there was some discrepancy. This formed the basis of divergence theory which was soon developed into a trading system on its own.
So, in the context of the forex markets, when price makes a new high, the oscillator also should make a new high.
Or when prices make a new low, the oscillator should ideally make a new low. When there is a discrepancy between price and the oscillator a divergence is identified. To spot the divergences in the forex markets, it is usually done comparing price to an oscillator. The most commonly used oscillators include:. For the sake of clarity, in this article we will explain the concept of divergence trading using the RSI 14 Indicator.
Divergence trade setups can be spotted in any time frames and are classified into two main types. 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. On the left side, you see an uptrend with two divergences.
However, the first one completely failed and the second one resulted in a massive winner. What was the difference? Such an approach will impact your performance in a big way. Divergences are a powerful trading concept and the trader who understands how to trade divergences in the right market context with the correct signals can create a robust method and effective way of looking at price.
Good article, especially these comments: When we take a look at the higher time frame on the right we see that the first divergences happened in the middle of nowhere and the second divergence formed at a very important resistance level yellow line and yellow arrow.
Very helpful to master the market!
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