How would you like to be given a reliable and low-risk method to be able to sell near the top and buy near the bottom of any trend? How would you like higher forex profits.
There is a way to do this, and it is well known in professional trading circles as trading divergence. Divergence can be defined as Forex market price action that is in conflict with one or more indicators. It does not matter what the indicator is. It can be any of the common oscillators you use, or any of the over-bought and over-sold indicators you are comfortable with. The very best thing about trading divergence in the Forex market is that you can use it as a leading indicator which means it can get you in early on a good trade, and out early or on time in a bad trade.
Divergence trading takes advantage of gathering and receding momentum, and if you are well-trained as a fx trader then you already know that price movement and momentum accompany each other as they almost always go hand-in-hand. Let’s assume that you are comfortable using the RSI (Relative Strength Index), and that you almost always have it installed on the bottom of your chart when Forex trading. What you are normally looking for when you are trading with the RSI indicator is a reading above 50, and preferably above 70. If the RSI indicator is above your bullish threshold and you get some other kind of entry signal you will likely lean toward buying the market when your plan is to trade from the long side, and you likely won’t look for any other kind of confirmation before you jump in so you probably will. After all, the RSI is above 50 right? So, yes, you might jump into the market at this point. Unless of course you understand divergence.
When you observe markets over the short run you notice the new short-term highs and the new short-term lows. These new short-term highs need to be accompanied by new highs in the indicator that you are watching otherwise you are experience a divergence, and a divergence many times signals a loss of momentum. What this means is that when you are looking at a short-term chart and you observe that the market has climbed to a new high level, but the RSI has not made a new short-term high, then you have a divergence and the market is telling you that momentum is fading even though that the back up in momentum is not at all visible to you within the price action itself. Be advised that the actual readings of the indicator that you are using are not relevant to this discussion, just the fact that the indicator has failed to make a new short-term high is enough to tell you that the probability of price continuing is not very great. Divergence is a great probability estimator.
Divergence trading is an great tool to have as it signals you that something less than fully kosher is going on at time when everybody else is either hyper-enthusiastic or in a state of panic, and that you need to pay closer attention to what is going on underneath the surface. Divergence is a reliable way for you to spot a failing trend or a market reversal. It can even be used to identify a trend continuation pattern.
Divergence trading applies only to recent price action and should be used to either confirm that a Forex market is trending, or to establish that a trend is ready run out of steam. To use divergence just draw lines on your chart connecting the tops of recent highs and bottoms of recent lows on both the price and on the chart indicator of choice. When in an uptrend you should see lines going up and to the right for both the market price of the instrument and also the indicator that you are using. When observing a down trend the opposite would be true. You would observe lines going down and to the right for both price and the indicator you are using. If you do not observe these little trends lines confirming each other then you have identified an instance of divergence and you can expect the market trend to run out of energy and perhaps reverse.
If you ever spot an incidence of divergence but the price has already reversed and moved the other way, then the divergence should be considered by you to be “played out”, and you should wait for the next set up to enter the online Forex trading market.
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