Now it’s time to put those Jedi divergence mind tricks to work and force the markets to give you some pips!
Here we’ll show you some examples of when there was divergence between price and oscillator movements.
How to Trade a Regular Divergence
First up, let’s take a look at regular divergence. Below is a daily chart of USD/CHF.
We can see from the falling trend line that USD/CHF has been in a downtrend. However, there are signs that the downtrend will be coming to an end.
While price has registered lower lows, the stochastic (our indicator of choice) is showing a higher low.
Something smells fishy here. Is the reversal coming to an end? Is it time to buy this sucker?
If you had answered yes to that last question, then you would have found yourself in the middle of the Caribbean, soaking up margaritas, as you would have been knee deep in your pip winnings!
It turns out that the divergence between the stochastic and price action was a good signal to buy. Price broke through the falling trend line and formed a new uptrend.
If you had bought near the bottom, you could have made more than a thousand pips, as the pair continued to shoot even higher in the following months.
Now can you see why it rocks to get in on the trend early?!
Before we move on, did you notice the tweezer bottoms that formed on the second low?
Keep an eye out for other clues that a reversal is in place. This will give you more confirmation that a trend is coming to an end, giving you even more reason to believe in the power of divergences!
How to Trade a Hidden Divergence
Next, let’s take a look at an example of some hidden divergence. Once again, let’s hop on to the daily chart of USD/CHF.
Here we see that the pair has been in a downtrend. Notice how price has formed a lower high but the stochastic is printing higher highs.
According to our notes, this is hidden bearish divergence! Hmmm, what should we do? Time to get back in the trend?
Well, if you ain’t sure, you can sit back and watch on the sidelines first.
If you decided to sit that one out, you might be as bald as Professor Xavier because you pulled out all your hair.
Well the trend continued!
Price bounced from the trend line and eventually dropped almost 2,000 pips!
Imagine if you had spotted the divergence and seen that as a potential signal for a continuation of the trend?
Not only would you be sipping those margaritas in the Caribbean, you’d have your own pimpin’ yacht to boot!