What Is the Best Divergence Trading Strategy? 👑

What Is Divergence?

Divergence is a trading phenomenon that offers reliable and high-quality information regarding trading signals. It refers to when an asset’s price moves in the opposite direction to the momentum indicators or oscillators. Commonly used indicators include the relative strength index (RSI), stochastic oscillator, Awesome Oscillator (AO), and moving average convergence divergence (MACD).

Divergence is one of the many concepts that experienced traders use to the time when to enter or exit the market. To say a divergence occurs is to say that the price and momentum are out of sync. This signals that the market is preparing for a trend reversal or pullback, but it does not necessarily guarantee trend directions.

There are mainly two types of divergence:

1) Regular divergence is where the price signal creates higher highs or lower lows while the indicator makes lower highs or higher lows respectively.

2) Hidden divergence, which is the opposite of regular divergence, is where the indicator makes higher highs or lower lows while the price action creates lower highs or higher lows respectively.

Regular Divergence vs. Hidden Divergence

What Is Regular Divergence?

Regular divergence can be divided into two types: regular bearish divergence and regular bullish divergence.

What is Regular Bearish Divergence?

Regular bearish divergence occurs when the price action makes successively higher highs while the indicator makes consecutively lower highs. This suggests that the asset’s price is preparing for a reversal into a downtrend. The indicator signal means that the momentum is changing. Even though the price action has made higher highs, the uptrend may be weak. In this scenario, traders should get ready to go short, i.e., to sell the asset and repurchase it later at a lower price.



What is Regular Bullish Divergence?


Regular bullish divergence happens when the price action forms progressively lower lows while the indicator creates higher lows. This implies that the prices will move in an upward trend soon. The indicator action implies that the price needs to catch up with the indicator signal and that the downtrend is weak. In this scenario, traders should get ready to go long, i.e., to buy the asset.



How to Trade Regular Divergence?

Divergence only tells traders that the momentum of a price movement is weakening. This does not necessarily lead to a strong reversal, and the price movement may just be entering a sideways trend (horizontal price movement within a stable range). To create a more reliable divergence trading strategy, skilled traders combine indicators with various tools. Regular bullish divergence and regular bearish divergence have different entry rules. In any case, once a trader has spotted a divergence, they should consider how to enter or exit the market and place their Stop Loss or Take Profit orders.

What’s a hidden divergence?

Divergences not only signal a potential trend reversal but can also be used as a possible sign for a trend continuation (price continues to move in its current direction).

Hidden bullish divergence happens when the price is making a higher low (HL), but the oscillator is showing a lower low (LL).



Hidden Bearish Divergence occurs when price makes a lower high (LH), but the oscillator is making a higher high (HH).



Keep in mind that regular divergences are possible signals for trend reversals while hidden divergences signal trend continuation.

Regular divergences = signal possible trend reversal
Hidden divergences = signal possible trend continuation

Conclusion

Trading divergence can be very profitable if traders can reliably identify divergence by making use of the trading tools in their arsenal. However, like all trading strategies, using divergence indicators involves a certain degree of risk.[