An Introduction to Divergence Trading

Divergence trading is one of the most efficient ways that a trader can conduct transactions in the forex, as it allows for potentially larger than usual profits and lower hazards. However, its rudiments are often misconstrued, so it imperative that the facts are laid out.

To make use of divergence trading in the forex, one should be versed in technical indicators or oscillators (MACD, Stochastics Parabolic SAR etc). The basic notion here is that the forex trader should compare the price movement in the currencies market with those displayed in the oscillator.

Divergence trading is classified under two groups: regular and hidden. The former suggests that the market trend is about to change, while the latter connotes continuity of the present direction. What a trader does is to check if as the price establishes new highs or lows, the oscillator will follow. If there is disparity, then there is divergence.

In regular divergence trading, if the price sets new lows, yet the indicators only points to the high low, then it could be a bullish sign. If the forex sets new highs but the indicator does not, then it is a signal for a bearish divergence.

In hidden divergence, one can conjecture the possibility of a bull run if the oscillator sets new lows and the forex price a higher low. If the oscillator sets a high and the price moves in the same, but lower, direction, then it is a bearish sign. Based on these movements a trader can make decisions on whether to buy or sell.

Before you incorporate divergence trading into your forex strategies, you have to make sure that there is one. Very often the market gives false signals, so make sure that the forex has established new highs or lows, or flat highs or lows.

If the forex points to that fact, then the next step is to put a connecting line between the two points. If they are peaks, then connect the tops; if they are valleys, then join the bottoms with the line. Now, verify this with your oscillators.

For a divergence to exist there must be similar points at which you can also illustrate the trendlines. Finally, compare both lines and if there is a deviation, you will see the difference in the curve. Provided that the currency prices have not remained in this position for a long period of time, then the divergence is confirmed.

Divergence trading does not happen as often as one would like in the forex, and when it does it is usually identified with long term charts, and so is suitable for long term trades. Although you can identify such tendencies in short term fluctuations, it is more difficult to ascertain.

As with everything in the forex, it takes some time to get used the jargon and the process involved in divergence trading in the forex. However, you should persevere, because the returns for your hard work and time spent can be substantial.