Chapter 18, Part III. Divergences with oscillators.

Part III. Divergences with oscillators.

Commander in Pips: As I’ve said, this will be the last part dedicated to divergences. I’ve seen that some traders use oscillators to identify divergences, such as Stochastic or RSI. Using oscillators has some nuances, since they are normalized indicators. Personally, I prefer to use MACD, but, if you’ll find that using stochastic or RSI is more suitable for you – pay close attention to some nuances.

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Pipruit: Thanks. And what nuances?​

AsstMod Note: I was wondering what happened to my rocket. Now I know.

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Commander in Pips: Now you will see them. Take a look at the first chart:

Chart #1 | weekly EUR/USD and fake divergence with Stochastic
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Do you see divergence here?

Pipruit: Well, I think mostly yes, than no. But sir, if I’ve taken this signal, I’ve got huge loss!
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Commander in Pips: That’s right. It comes from math of oscillators. They are normalized, hence they could not move above 100%, even if market continues move up. So they will show you divergences even when they are not exist.

Pipruit: And what we should to do then?
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Commander in Pips: Remember these 2 rules.

1. Be careful with using a normalized oscillator for Divergence estimation;

2. Always wait for line crossing and exit of oscillator from overbought /oversold zones.

If you’ve taken the signal after these rules has accomplished – you have the possibility to earn some pips or at least move your stop to breakeven.

On chart #2 we show much better divergence, because Stochastic stands outside the overbought area:

Chart #2 | weekly EUR/USD better divergence with Stochastic

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And here is example of hidden bearish divergence with Stochastic. Here again, the first top is not in overbought, hence this divergence has more chances of success. As we can see it has worked well, and the down move has continued:

Chart #3 | weekly EUR/USD hidden divergence with Stochastic
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