Finance

Making trading decisions with lesser risk through divergence

What is divergence?

It is normal to feel unsure about certain trading decisions since some options can be risky. There is a trading called divergence that can let you avoid certain risks. You can find them when you compare price action and indicator movements. And when we say indicator movements, we mean that you can use any indicator that your heart desire and technique requires. Divergences can serve as leading indicators. It may be challenging to spot them, but experience and hard work can be of great help. If you learn them by heart and know how to apply them in trading properly, you are surely getting that hefty profit. Here are some of the things that divergences can do:

  • Selling near the top and buying near the trend’s bottom with fewer risks
  • An entry with a lesser risk when you want to go short on a currency pair that seems to decline
  • A suitable exit when your long position tend to reverse direction

More on divergences

We usually buy near the bottom and sell near the top when we use divergences. As a result, there is lesser risk compared to the reward that you expect. Divergences tend to be about higher highs and lower lows. Price and momentum are usually together. Furthermore, if the price makes higher highs, so does the oscillator. The same fact is true when the price makes lower lows; the oscillator will make lower lows too.

So, what if they do not? It can only mean that there is a divergence between the price and the oscillator. Divergences help you realize that there is something wrong with your trade. It can help you spot a trend getting weaker or a reversal in momentum. Also, it can serve as a continuation signal on some occasions.

What are regular divergences?

We can classify divergences into two types, namely: regular and hidden. Regular divergences can serve as a potential sign for trend reversals. They can either be bullish or bearish.

First, we have the regular bullish divergence.

A regular and bullish divergence composition is a price making lower lows and an oscillator making higher lows, and they often happen on the latter part of a downtrend. As soon as the second bottom establishes, the oscillator could not create a new low, leading to a price increase since price and momentum usually move in line together.

If there is a bullish, there is also a regular bearish divergence

A regular and bearish divergence is composed of a price that makes higher highs and an oscillator that makes lower highs. We can often encounter them on uptrends. As soon as the price made the second, the oscillator could not make a lower high, leading to a price reversal and even a drop.

When is the best time to use regular divergence?

The best time to use them would be picking tops and bottoms and areas the price stops and reverses. The oscillator tells us that the momentum is about to shift even if the price made higher highs or lower lows and will not most likely be sustained. Aside from the regular divergence, there is another type of divergence, which is hidden divergence. It does not hurt to know many things that can help you in trading, right?

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