Divergence Trading Strategy: Overview, Rules, Backtest Analysis

Divergence Trading Strategy: Overview, Rules, Backtest Analysis

A step by step guide to help beginner and profitable traders have a full overview of all the important skills (and what to learn next 😉) to reach profitable trading ASAP. In the paragraphs below, we will explain two trades that were made because of several MACD histogram divergences that appeared on the USD/JPY daily charts. Try a powerful cluster chart analysis tool for stock, futures and crypto markets.

  1. The chart shows how a bullish divergence is formed when the lows, which are going down, on the candles (1) do not match the going down lows on the indicator.
  2. Netflix quickly enters a downtrend, which we have marked with the pink downtrend line.
  3. Positive divergence happens when the price of a security makes a new low while the plotted indicator starts to climb.

EUR/USD stalls at a major level of resistance, and there is bearish divergence at the same time, the odds for a reversal have just increased. Some foreign exchange traders regard oscillator divergences as the holy grail of technical analysis. Others consider these elusive chart patterns to be virtually useless. As we stated earlier, the accuracy of divergence trading depends on the timeframe you are trading. The higher the timeframe, the more reliable the divergence signal. But even on the higher timeframes, divergence trading is not accurate, as it fails more times than it succeeds.

Nonetheless, there are many indicators you can use for the divergence strategy. Some of them are purely price-based indicators, while some are based on volume data alone or a combination of price and volume data. On the low side, the price may be making a lower low, while your indicator is making a higher low, or the price is making a higher low, while your indicator is making a lower low. Select a reputable trading platform that offers access to your preferred assets, such as stocks, forex pairs, or commodities.

Types of Divergence in the Stock Market

The data was taken from the CME exchange, timeframe 10 minutes. A regular bullish divergence signifies that a bearish trend will go down and an upward reversal is likely to happen. You are now looking at the 10-minute chart of Netflix from Aug 16-23, 2016. When you spot a disparity on the chart, you shouldn’t just hop blindly into your trade. You should first wait for price action to confirm the divergence signal. This conflict of price and technical indicators is one of the strongest signals in trading.

Divergence Trading: How to Trade Bullish and Bearish Divergence

A bearish divergence in stock trading is created when the price action is moving higher, while your indicator of choice is making lower highs. Location is a universal concept in trading and regardless of your trading system, adding the filter of location can usually always enhance the quality forex sentiment analysis of your signals and trades. These are signs that the trend will continue, whereas regular divergences indicate a reversal of trending price action in a trade. In the case of bearish regular divergence, spot situations where the price forms higher highs while the indicator forms lower highs.

The same Covid-pandemic market crash created a hidden bullish divergence on the Tesla stock (TSLA) chart — on the D1 timeframe. The divergence is called hidden bullish because while the TSLA price made a higher swing low, the RSI oscillator made a lower low. That was followed by a tall bullish engulfing candlestick https://bigbostrade.com/ pattern, which would have been a good trade trigger for those watching the divergence. The key thing in divergence is the configuration of the swing highs and lows of both the price and the indicator you are using. In trading, divergence means that the price swings and the indicator movement are not in phase.


Follow these rules, and you will dramatically increase the chances of a divergence setup leading to a profitable trade. Divergences on shorter time frames will occur more frequently but are less reliable. All you can do now is wait for another swing high/low to form and start your divergence search over. In the “pink” example, the pink lines show where divergence is present.

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The Moving Average Convergence Divergence (MACD) is both a momentum and trend following indicator.It is calculated by… With the passage of time and practice, you will be more proficient to spot divergences in real-time and to capitalize on them. Learn everything you need to know about forex trading and how it works in this guide. Below is an example of bearish divergence on the EUR/USD currency pair.

Hopefully, you can now see why trading divergence can be a helpful technique for adjusting your position sizing, reducing risk, and identifying clear trading opportunities. Indeed, it can help you stay on the right side of price action on many time frames, small and large. Number 2 shows that two peaks are also forming on the indicator chart, however, the second one is much lower than the first one. This is a bearish divergence which warns traders that it is difficult for the price to go up and a decline is likely to occur in the coming days. The key problem with using shorter timeframes is the noise, which causes many false signals.

It’s a simple indicator that consists of an indicator line, zero line, and overbought and oversold areas. The CCI indicates that the price of an asset is above the historic average when it’s above zero and below the historic average when it’s below zero. If the indicator line rises to above 100, it gives a sell signal.

A bearish divergence occurs when the price moves upwards, but the MACD histogram moves downwards, indicating a potential downtrend reversal. This knowledge enhances traders’ ability to time their trades, manage risks, and ultimately improve their overall trading success. This quick reference guide highlights the various trading divergence patterns that may appear on a chart.

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