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Divergence Forex – how to trade them?

When learning Forex, divergence Forex trading is a key concept. Divergences are common signals in graph analysis. It’s an early signal showing the trend reversal and filtering false signals. So, what if you can sell at the high or buy at the low of the trend? What if you think a currency pair will continue to fall while wanting to enter at a more advantageous price or a less risky level? Guess what? There is a way! It’s called divergence trading.

What is divergence?

A divergence is visible when the indicator evolves in the opposite direction to the price trend.

Although giving good indications, divergences do not give direct entry signals. It is often necessary to supplement the signal with another method to determine an interesting entry.

The appearance of a divergence informs us of the weakening of the current trend. Nevertheless, it is possible that the reversal signals will not take effect immediately. This is the reason why we avoid trading only with divergences.

What is Forex divergence trading?

 

Divergence trading is when the price moves in a different direction than an indicator.

There are a number of different indicators that can be used to detect divergence, but the most commonly used indicators for divergence trading are MACD, RSI, and Stochastic oscillator.

Divergence trading is most often used to find out when a trend is weakening, and a trend reversal might occur.

You can identify the two types of divergences: direct and hidden. These two have subcategories: those that indicate an uptrend and those that indicate a downtrend. We then speak of positive and negative divergence.

You can also use divergence to gauge the strength or momentum of a current trend. This can give you better insight into the direction the price might be heading.

Main types of divergence Forex

There are three types of divergence: direct, hidden, and regular. All have their bullish and bearish biases. However, some trailers also include extended divergence as a fourth type. 

Regular divergence

It represents a possibility of a trend reversal. A regular bullish divergence happens when rates decrease to new lows, and an oscillator doesn’t reach a new low. It indicates bears are overtaking the market. Regular bearish divergence is the opposite situation. We can spot the trend reversal where the bulls are overtaking the market. To detect bullish divergence, you have to analyze the price highs and the lows recorded by the indicator.

Direct divergence

  • Bullish Direct Divergence

A bullish divergence occurs when prices mark lower and lower lows, and the indicator marks higher and higher lows. This indicates that the downtrend is running out of steam and potentially signals a bullish reversal.

  • Bearish Direct Divergence

Here we will identify a bearish divergence when the prices register higher and higher highs, and the indicator shows us higher and lower highs.

The hidden divergence

types of divergence Forex

Unlike direct divergences, hidden divergences indicate a continuation of the trend.

Less obvious to the eye (hence their names), they are no less effective.

  • Hidden Bullish Divergence

This divergence is characterized by higher and higher lows on prices and lower and lower lows on the indicator. It indicates a bullish continuation.

  • Hidden Bearish Divergence

We can find a bearish divergence when prices mark lower highs while the indicator marks higher highs. We will then have a bearish continuation indication.

In simple terms, divergence can be defined as comparing the price action and the movement of the indicator. It doesn’t matter which indicator you use. You can use the Relative Strength Index (RSI), the moving average divergence/convergence indicator (MACD), the stochastic indicator, the CCI, etc.

The great thing about divergences is that they can be used as leading indicators, and after a bit of practice, it won’t be too difficult for you to use them.

When traded correctly, divergences can consistently prove profitable. The most interesting aspect of divergences is the possibility of buying near the bottom or selling near the top. This limits the risk of trading relative to the potential gain.

Extended Divergences Forex

Some investors consider it as a third type of divergence for Forex. Some consider it a false signal. It’s quite similar to hidden divergences. But they may occur in sideways trends and don’t show precise prices low and high. It’s rather an indicating trend continuation.

Divergence Forex – main principles

If you want to grasp all types of divergences, you need to understand the main principles of spotting them.

1. The primary feature is when a double top or double bottom pattern appears in the price chart.

2. Any divergence is discovered only according to the highs or lows in the price chart and on the divergence indicator.

3. Price highs and indicator highs should correspond to each other.

Trading divergence in Forex – how to spot divergence

 

How to spot a divergence in Technical Analysis? When to take a position and when to settle this position?

Simple questions that we inevitably ask ourselves when we want to invest using divergences or any other technique. 

We can observe a divergence when the price of an asset shows, i.e., makes new highs while the technical indicator used (Momentum, RSI, MACD, Stochastic…) makes a first high followed by a high point lower than the previous one. The indicator thus highlights a weakness of the indicator and, therefore, a potential trading opportunity, but it is all about theory. In practice, it is not always so obvious.

How do you use an oscillator for divergence? Just think of maximum highs and lows. Price and momentum usually move hand in hand.

The oscillator should also do the same if the price makes higher highs. If the price goes to the bottom, the oscillator will follow it. If they do not act simultaneously, it can mean that the price and the oscillator diverge from each other. This is called a “Divergence.” 

Trade divergence forex – a step-by-step guide

So here is a step-by-step guide to trading divergence in Forex.

  1. Identify the trend direction in the analytics chart.
  2. Determine two consecutive lows and highs and identify the divergence.
  3. Link the RSI or MACD histogram with the price chart. Determine highs and lows using indicators corresponding to price extremes.
  4. Once you find divergence, the price and indicator determine the direction of the signal.
  5. Then find the entry point and set the stop-loss at a distance from the lowest low/highest highs. The basic strategy requires putting a take-profit at a distance twice as long as that of the stop loss.

RSI divergence Forex

In theory, the RSI (Relative Strength Index is a trading indicator from the family of oscillators) is supposed to follow the same movements as the price; it happens, however, that the curves do not represent the same shape. We then speak of divergences. 

For bullish divergences, only the bottom of the curves is taken into account. The price has a strong chance of going higher after one of these two figures.

The regular divergence is more likely to arrive at the end of the downtrend. We then witness a reversal. At the same time, the hidden divergence is already in an uptrend, which strengthens it.

For bearish divergences, only the top of the curves is taken into account. The price has a high chance of falling after one of these two figures. The regular divergence is more likely to arrive at the end of the uptrend. This is a sign of exhaustion, so we are witnessing a reversal. 

Divergence Indicator for MetaTrader 4 and MetaTrader 5

How to set up the MT4 alert indicator and MT5 alert indicator?

This indicator from MQL5 is one of the most in-depth divergence indicators you can use on MT4, and it is also free.

You can apply this indicator in any market and time frame you want, and it has many settings that you can customize.

There are 30 different oscillators to choose from to find the divergence, and when you set up the indicator, you get clear layouts on your charts.

MetaTrader 5 divergence indicator is a free divergence indicator for MT5 that gives you buy and sell signals. These signals are displayed as green and red arrows on your charts.

A very interesting feature of this indicator is that it has built-in alerts so you don’t miss any potential trades.

The indicator is constructed using the MACD to find potential divergence trades.

There are two types of divergences that you can use in your trading. One type can help you spot a potential change in the trend, and the other can help you see when a trend is looking to continue.

Conclusion – Divergence Forex

Divergence trading is a great tool that you should have in your arsenal because divergence signals tell you that an opportunity is brewing and that it deserves your full attention.

Divergence Forex trading strategy can help identify a weakening trend or a reversal in momentum. 

However, as powerful as it is, it remains incomplete. It would be illusory to take positions solely on the appearance of divergences. In short, you must know how to use it wisely, i.e., as information on the current trend. Trading only divergences would be like trading chart figures by anticipating breakouts.

Divergence Forex – FAQ

FAQ

What is divergence Forex?

A divergence is visible when the indicator evolves in the opposite direction to the price trend.Divergence trading is most often used to find out when a trend is weakening, and a trend reversal might occur.

What are the main divergence indicators?

The most used divergence indicators are MCDI, RSI, Stochastic oscillator, and Bollinger bands

What are the main types of divergence in Forex?

There are three types of divergence: direct, hidden, and regular. All have their bullish and bearish biases. However, some trailers also include extended divergence as a fourth type.

Does divergence work in forex?

First of all, although divergence signals may work on all timeframes, longer-term charts (daily and higher) usually provide better signals.

What are the three types of divergence in Forex?

There are three types of divergence: direct, hidden, and regular. All have their bullish and bearish biases. However, some trailers also include extended divergence as a fourth type.

Is RSI divergence reliable?

Yes, it’s a highly predictable divergence indicator besides MACD. Many traders also monitor the MACD for signs of momentum diverging from price.

How to spot divergence in Forex?

We can observe a divergence when the price of an asset shows, i.e., makes new highs while the technical indicator used (Momentum, RSI, MACD, Stochastic…) makes a first high followed by a high point lower than the previous one. The indicator thus highlights a weakness of the indicator and, therefore, a potential trading opportunity, but it is all about theory. In practice, it is not always so obvious.

 



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