The forex market is all about timing your trades well. Divergences give traders a market reversal signal right before a price trend changes and helps place successful entry or exit orders. In our article, we will understand everything about Divergences and how to trade them.
What does divergence mean in forex?
A Divergence occurs when a currency pair price moves in the opposite direction of the current market trend.
- When the Divergence is in the upward position, it is called a positive Divergence and it signals a bullish market trend. While the technical indicator shows increasing results, the currency pair prices fall.
- When the Divergence is in a downward position, it is called a negative Divergence and it signals a bearish market trend. While the technical indicator shows decreasing results, the currency pair prices rise.
What are the types of Divergences?
Regular Divergences
A regular Divergence is one of the most common reversal Divergences. As part of your forex divergence strategy, Iit is a leading indicator as it provides traders with buy and sell levels near the low and high prices accordingly.
- A Regular Bearish Divergence occurs in an uptrend where the currency pair prices touch higher high levels, and the indicator values touch a lower high level. This signals traders to place sell orders at the higher high currency pair price levels and exit the market before a bearish reversal occurs.
- A Regular Bullish Divergence occurs in a downtrend where the currency pair prices touch the lower low levels, and the indicator values touch a higher low level. This signals traders to place buy orders at the lower low currency pair price levels and enter the market before a bullish reversal occurs.
Hidden Divergences
A hidden Divergence is a continuation indicator that is used for trading along with the existing trend.
- A Hidden Bearish Divergence occurs during a downtrend when the indicator values touch higher highs and currency pair prices touch lower highs. It signals traders about a downward continuation price trend and provides them with the ideal price level to exit/sell the trade.
- A Hidden Bullish Divergence occurs during an uptrend when the indicator value touches a lower low-price level, and the currency pair prices touch a higher low level. It signals traders about an upward continuation price trend and provides them with the ideal price level to enter/buy the trade.
Top indicators to spot Divergences
1. Moving Average Convergence Divergence (MACD)
The MACD indicator is a trend-following technical tool that shows the relationship between a fast-moving average and a slow-moving average. When the MACD line crosses its signal line (9-day EMA) from above, it is a bullish divergence and signals traders to place entry/buy orders. However, when the MACD line crosses its signal line from below, it signals traders to place exit/sell orders due to a bearish divergence.
2. Relative Strength Index (RSI)
The RSI is a technical indicator that indicates overbought and oversold market conditions by measuring how frequently the currency pair prices change. During a downtrend, when the currency pairs are oversold, the RSI signals a positive divergence, indicating traders to place long orders due to a bullish reversal expectation. During an uptrend, when the currency pairs are overbought, the RSI signals a negative divergence, indicating traders to place short orders due to a bearish reversal expectation.
3. Stochastic Oscillator
The Stochastic Oscillator is a momentum indicator that compares the closing currency pair price to its price range (between the support and resistance level) to predict trend reversals. The Stochastic Oscillator always trades between a range of 0 to 100, and when the readings are above 80, it indicates an overbought market level, signalling a downtrend reversal divergence, where traders can sell/exit the trade. The readings below 20 indicate an oversold market level, signalling an uptrend reversal divergence, where traders can buy/enter the trade.
4. Commodity Channel Index (CCI)
CCI is a technical indicator that is used to measure the difference between the currency pair's historical average price and current price to generate exit/entry signals. When the current currency pair prices are below their historical average prices, the CCI marks a higher low, indicating a bullish divergence and signals traders to enter the market. However, when the current currency pair prices are above their historical average prices, the CCI marks a lower high, indicating a bearish divergence and signals traders to exit the market.
How to Trade Divergences in forex?
- Identify the existing trend direction in the market.
- Find out the currency pair highs (or lows) and the technical indicator's lows (or highs) in order to spot the divergence level.
- After identifying in which direction both the currency pair price and indicator value is moving, identify the trend's direction in which it is moving.
- If the trend is following an upward movement, it is a bearish divergence signal that indicates traders to place sell/short orders. However, if the trend is following a downward movement, it is a bullish divergence signal that indicates trades to place buy/long orders.
- The stop-loss order can be set away from the current price at a distance from the highest high price level or lowest low price level.
- The take profit order can be placed at a distance of two times as much as the stop loss level.
Trade Divergences today to spot ideal entry and exit levels
To trade the market reversals successfully, Divergences play an important role as they compare the currency pair prices with the indicator's values. With our Blueberry, you can trade Divergences seamlessly and experience tight spreads with priority support. Sign up for a live trading account or try a demo account.
Disclaimer:
- All material published on our website is intended for informational purposes only and should not be considered personal advice or recommendation. Traders should carefully consider their objectives, financial situation, needs, and level of experience before entering into any margined transactions.