Trading divergence is one of my favorite trading strategies because divergent strategy offer very reliable 1
signals when combined with other indicators. Divergence can be used to know the exit point for trend following 2
traders but they can be used to trade reversals also. 3
let us understand the most obvious question what is divergence. A divergence 4
occurs on the chart when prices and the indicator that we use are going in opposite dedication. In normal 5
conditions the price and indicators should move in the same direction. 6
You can see here that prices are going in upward direction and RSI is also going in a upward 7
but when indicator and price action are out of sync it means something wrong is there with the trend and 8
needs attention, 9
why the indicator is not agree with the price action. we can see here that prices are moving in a downward 10
direction. 11
Also RSI is moving in a downward direction but see these two troughs, 12
These are the troughs of RSI and these are going in downward direction you can see they are going 13
in downward direction but RSI trough is going an upward direction so prices and indicator is moving 14
in opposite direction. 15
Similarly you can see prices are going in upward direction, 16
RSI is also going in a upward direction but when RSI is an overbought range it means 17
that prices are now overbought and we can see a consolidation in the prices. 18
Also we see the peaks of RSI 19
This is the first peak and this is the second peak. Peaks of RSI is going in downward direction 20
But if you see the price action on the chart these are the two peaks and they are going in upward direction. 21
So indicator and price are not in agreement and there is something wrong with the trend. 22
After that you can see that prices are consolidating here for some time and then we can see a retracement 23
in the price. 24
So when the troughs of the price and troughs of RSI are not in agreement and troughs of RSI 25
or the other indicator that we use like MACD, stochastic chikin oscillator. if indicator is going in 26
upward direction, 27
This is called bullish divergence and it signals that this downtrend may end now. in this case prices are 28
going in upward direction but RSI is going in a downward direction. 29
It shows that uptrend can end now and the downtrend is imminent or 30
we can see that retracement is imminent now because the price action and indicators should agree 31
and they should move in the same direction. see this is the hourly chart 32
of USDJPYand here prices are in upward direction but if we see the indicator RSI peaks are going 33
in downward direction and see MACD is also giving a bearish divergence because MACD is going in downward 34
direction but prices are going upward direction. 35
It shows that momentum is low here. 36
Now as long as there are higher highs on chart, See this is the uptrend. There are 37
Higher highs and also RSI is going in upward direction. 38
It means that trend is progressing but when price is making a higher high and indicator is making 39
a lower high 40
Also MACD is making lower high here 41
it means that recent price action is not as strong as the previous price action and trend 42
is losing momentum. 43
It doesn't mean that trend will reverse now but it signals about the pause in trend. 44
It signals that either the buyers are exiting from their position or sellers are getting in. because 45
you can see this is the strong resistance level for the prices 46
Here prices are taking rest on this line and now this peak is resisting the Level 47
These two peaks are resisting the level so here at this point this level is acting as a strong resistance 48
Level. 49
So near this level we can expect a consolidation in the prices. at this point 50
Bulls and bears are fighting with each other. 51
If there is a fresh buying then trend will resume its direction and prices will go higher. 52
And if sellers are more than buyers then trend will reverse the direction. so when prize and indicator are 53
out of sync it really requires your attention that something is happening on the chart 54
And this is called divergence. 55
As we already know divergence can be either bullish or bearish. A bearish divergence forms when 56
prizes make higher high but indicators make lower high. 57
You can see here that these peaks are going in upward direction, they are making higher high but indicator 58
is making lower high. 59
See these are the highs but this high is lower than this high so these highs are going in downward trend 60
also on MACD, 61
there are lower highs and going in downward direction. 62
So this is called the bearish divergence and it signals about the end of the uptrend and a bullish divergence 63
forms on the chart, 64
When prices makes lower lows but indicator makes higher lows. lows mean troughs so when we find a bullish 65
divergence we always see the troughs of the price and the indicator. 66
See these troughs are going in downward action but the troughs of RSI is going in upward direction. 67
Also the troughs or lows of MACD is going in upward direction so this is called the 68
bullish divergence. For good signals, at least one peak or trough of 69
indicators should be in overbought or oversold region. 70
It means that price is already in overbought range and when price starts to lose momentum we should 71
exit from the trade and see the price action near the support level. 72
See this was the downtrend so we will see price action at this level and if we get a confirmation with 73
the indicators then we can exit form our old trade and make fresh entry in the new trade. 74
But for this we should get a confirmation and how to get confirmation with the indicators that we will 75
learn in the next lecture how to trade divergence accurately. See here is a signal of bullish divergence 76
and if we see that chart 77
This is a strong support level. 78
You can see here prices are taking support so this was a support level and when prices reach at this 79
level, at this support level there is already a Bullish divergence. 80
So we can make our buying position but for this we should draw a trend line for this trend that we will learn 81
in the next lecture, how to draw these lines for the trend and for the RSI also. 82
Thanks for watching, I'll see you in the next lecture.