Stock Alphabets: RSI Divergence

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. Nine rules you MUST (should?) follow if you want to seriously consider trading using divergences.

  • Click the ‘Open account’button on our website and proceed to the Personal Area.
  • How to Read Trading ChartsTrading forex live charts can help identify ongoing market trends, which can help you place successful traders.
  • Classic technical analysis tells us that a trend exists when price makes a higher high – but like too often, conventional wisdom is seldom right and usually simplifies things too much.
  • These are indicators such as MACD, RSI, Stochastic, CCI, etc.
  • Convergence does not indicate any Buy order but it discourages traders from placing Sell order.

The market draws a double top, but the second price peak may be slightly higher or lower than the previous value. Even if the top levels divergence forex are the same, the indicator will show a lower second high. The indicator will not draw the double top that is seen on the price chart.

Divergence In A Nutshell

When set to the default 14-period setting, the RSI indicator gives few overbought and oversold readings. That means that when it comes to using divergence as a trading signal, there tend to be less signals but they are more reliable when they occur. The concept of divergence as a guide in trading has been around for many decades and was popularized by Gerald Appel, inventor of the moving average convergence-divergence indicator . In recent years, divergence trading has become increasingly talked about as a stand-alone or near stand-alone technique. A situation where the price candles’ tops or bottoms point in a different direction from the corresponding tops or bottoms of the indicator’s signal line is called a divergence. The oscillators are used because they are leading indicators. They tend to point in the direction of the next price move, before this appears on the charts.

divergence forex

Using the divergence of a technical indicator from the movement in a market price is a day trading technique especially popular with forex traders. Comparing slopes on the same GBP/USD daily chartIn fact, the horizontal slope of the indicator line means that momentum has returned to zero. Since momentum is a leading indicator, this is good news, if sometimes ambiguous. The price and the MACD both fell in sync, but after the spike low, the price proceeded to put in a series of mostly higher lows while the MACD was flat. Flat vs. rising lows is still a form of divergence, since the meaning of the flat MACD is that momentum has stopped falling.

How To Draw Divergence

Now look at your preferred technical indicator and compare it to price action. If the chart shows an extended bullish divergence, you need to look for a buying opportunity as prices go up. When the RSI makes similar highs during an uptrend it means that the momentum of the trend is unchanged. When the RSI makes an equal high, it does not qualify as a divergence because it just means that the strength of the uptrend is still up and stable. Higher highs on the RSI do not show a reversal or weakness. Basically, a divergence exists when your indicator does not “agree” with price action. Granted, this is very basic and we will now explore more advanced divergence concepts and see how to trade them, but it’s important to build a solid foundation.

divergence forex

Usually divergence is hidden and not immediately obvious until it has occurred. Such tools include the Fibonacci retracement tools, which are able to detect the exact pullback levels and match them with the higher lows formed by the price bars/candles. A hidden bullish divergence is a setup where the oscillator forms progressively lower lows at the same time that the price is forming higher lows. This setup is frequently seen in situations where the price has been in consolidation or has performed a pullback from an uptrend. This setup, therefore, indicates that price still has some upside momentum and that any pullback is more likely the outcome of profit taking from previous buyers as opposed to strong selling. The emergence of a hidden bullish divergence represents a signal that the prior uptrend is likely to continue. The hidden bullish divergence is presented in this setup below.

How to Spot Bullish and Bearish Divergence Patterns

The bullish divergence RSI setup shows two troughs in the RSI indicator window forming higher lows while the price shows lower lows. The RSI, therefore, leads the price action and is pointing in the new direction. The price follows directly after to correct the divergence in the direction of the indicator’s signal. Relative Strength Index helps traders understand how frequently the currency pair prices change in the forex market to predict the future market prices.

How to Trade Divergences in forex?

Now, one thing is for sure, we know I’m not talking about the movie/novel. But on the charts, Divergence is a phenomenon where the price and the indicator are not moving in the same direction, and yes you said it, they diverge from one another. Stochastic is a momentum technical indicator that works by comparing the last closing price with a range of previous prices over the last 14 periods. The logic behind divergence to analyse the market price is that the indicator is showing a slowdown in momentum of the price. The momentum of the price will often change before the price itself. The vast majority of retail investor accounts lose money when trading CFDs.

However, it is not at all necessary to observe higher maximum price values ​​on the chart. It is enough that the previous peak is slightly lower than the next one. We rely on reader support and your contribution will enable us to keep delivering quality content that’s open to everyone across the world. Our gain and loss percentage calculator quickly tells you the percentage of your account balance that you have won or lost.

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