Unbiased Forex Broker Experts

Part I. Divergence Intro

Divergence Intro - Forex School
Pipruit: Commander, does there exist some tool that with solid probability allows us either to sell on top or to buy on bottom?​

Commander in Pips: There is some. It calls Divergence/Convergence. Although this signal you can meet very often on market, it demands a proper approach to its trading. Because acting based on it blindly often will lead to losses rather than to profit.

To determine divergence or convergence, you have to use chart with some indicator - Forex School
Pipruit: I remember something that you’ve told about it earlier, but just slightly. Could you specify a bit more, what is divergence?
Commander in Pips: Well, to determine divergence or convergence, you have to use chart with some indicator. Most commonly are used RSI, MACD, and Stochastic sometimes. Personally, I use MACD. The major idea is that most time price action and its momentum based on some indicator move together. It means that both price and indicator creates new highs and lows simultaneously. But sometimes, price on the chart makes new highs/lows but the indicator does not support that, so they diverge from each other – that’s why it is called divergence.

Pipruit: And what is Convergence?
Commander in Pips: Well it’s absolutely the same. The point is that divergence appears on tops, when price creates new high but the indicator does not. So it looks like price and the indicator diverge from each other. But on bottoms, when price creates a new low and the indicator is not, it looks like price and indicator converge each other. Very often as on tops as on bottoms this kind of price action is called divergence. The difference uses mostly to accent on the nature of divergence – divergence is a bearish pattern, while Convergence is bullish. So, if somebody speaks about Convergence, it means that this is bullish divergence on a bottom.

Pipruit: I see. And what is the advantage of divergence?
Commander in Pips: The major advantage is that it forms near extremes. It could be as local as major extremes. So as it forms at extremes, i.e. tops and bottoms, it allows us to establish position at a top or bottom. In other words, you have the chance to sell on top and to buy at bottom – that’s what we want to do.

Pipruit: Cool! So, I have to buy any time when I see convergence and sell any time when I see divergence, right?
Commander in Pips: Wrong. You have to know already, that as some pattern becomes more popular it gets trickier. Trading divergences is not a piece a cake – it fails as often as it works or even more often. It means that we need some parameters that will allow us to filter divergences and to shift the odds of its trading in our favor.

Pipruit: Right. And how we will do that?
Commander in Pips: First we will start from description what kind of divergences exists in the market. Then we will discuss how to better to deal with them.

Common Divergences

This kind of divergence you can see very often on any market and on any time frame. They look like the explanation above. Let’s take a look at chart #1 to make it more clearly for you:

Chart #1 | 60min EUR/USD MACD Bearish Divergence
60min EUR/USD MACD Bearish Divergence - Forex School
Pipruit: Wow, cool! I’ve seen this kind of price action before and guessed that this should mean something, but was not able to understand it properly.​

Commander in Pips: Here on chart #2 is an example of bullish divergence, aka convergence. You see, that this kind of pattern is very common and often on market – two convergences (smaller and larger) stand side by side to each other. After every pattern, the market has shown a nice move up.

Chart #2 | 60min EUR/USD MACD Bullish divergence (Convergence)
60min EUR/USD MACD Bullish divergence (Convergence) - Forex School
Pipruit: And does divergence always lead to strong reversals?​

Commander in Pips:
 Probably not. The point is that divergence is used by traders to estimate reversal points. Although some reversal could appear, it is not always a drastic reversal. As with other reversal patterns, it could lead only to some retracement against the previous trend, sometimes even to very shallow retracement.

Pipruit:
 And how we should involve this knowledge in trading divergences?​

Commander in Pips:
 Well, one of the major aspects of divergence is the time that passed on forming a particular divergence. Let’s take a look at chart #2. See, first small divergence was forming about 20 hours. Thinking in terms of time – the followed move up was a drastic reversal compared to price action during those 20 hours, but in terms of daily chart, this move will be insignificant. The same is true for the second divergence. It looks huge compares to first one. The followed move up was also solid, in terms of time and price value of this divergence.

Pipruit:
 And so what?​

Commander in Pips:
 The point is that you should not expect move for 500 pips from divergence on 5-min chart. Moves based on divergence and the time and market swings of divergence itself have to be comparable. Sometimes, you can see that a strong long-term trend has started from divergence on an hourly chart, but this does not happen very often and mostly not due to the divergence itself. In this case, divergence is just a part of the overall puzzle. But traders who do not see other signals think that this long-term daily trend has started due to divergence on hourly chart. That is not quite correct.

Pipruit:
 So, we can’t use short-term divergence for judging long-term perspectives?​

Commander in Pips:
 Not quite. As I’ve said “part of the puzzle”. It could be used, for instance, if you see strong weekly support and are watching for buy signals that allow you to jump in based on a bullish weekly context. Here you can use daily, or say, even hourly divergence to jump in. But here you treat this divergence not as a single context for trading, but just as a trigger of your expectation. The reason for trading is quite different – weekly bullish context. Divergence here is just a bell that probably your expectations have started to materialize.

Pipruit:
 Very delicate thoughts, Commander. But now it becomes clear. Thanks.​

Commander in Pips: Not at all. Still, let’s return back and take a look at a schematic view of divergences, as in pictures below. Here we can say, that:

1. If the market makes lower lows but the indicator makes higher lows – this is bullish divergence or convergence. This signal is expected to appear at the end of a downtrend;

2. If the market makes higher highs but the indicator makes lower highs – this is bearish divergence. This signal expected to appear at the end of uptrend;

3. Usually, an “indicator” is used MACD or RSI, but some traders use CCI or, say, even Stochastic;

4. Divergence could lead as easily to a reversal as to some retracement - although price makes new extreme, the indicator shows that momentum in this direction is fading and we can count on some reversal;

5. Use divergence according to time frame and the time that passed on its forming;

6. Divergence could be used as an additional signal in a larger time frame trading context.

Divergence could be used as an additional signal in a larger time frame trading context - Forex School
Pipruit: Nice pictures. Commander, I’m looking at chart #1 and see that divergence combined with Head & Shoulders pattern. Does it always happen with divergences that it is a fellow traveler of reversal patterns?​

Commander in Pips:
 Well, I suppose that you’ve noted already that reversal point on the market starts not occasionally. And very often, when some reversal pattern forms, say, H&S, there are some additional patterns that appear with it - bearish engulfing, Butterflies, AB=CD and others. Since divergence a reversal pattern – it could be a companion of other patterns – 3-Drive, Wedge, Broadening Top/Bottom, Double Top/bottom, H&S and others.

Appearing of more than just a single pattern will give you much more confidence in the safety of a particular signal. This is one of the major properties of reversal patterns. This is, by the way, the initial thought that lead us to an approach how to filter failed divergences. We will talk about it a bit later.

Skewed divergences

This kind of divergence is a continuation patterns, rather than a reversal one. The major difference here with common divergence is the indicator and price exchange their places – on bullish divergence, the indicator makes a lower low, but price does not. On the bearish divergence, the indicator makes higher high, but price does not:

Skewed divergences - Forex School
As we’ve said almost in the beginning of our School – “The trend is our friend”. So skewed divergences could let you estimate continuation of a trend. If the market was in uptrend then turns to some retracement or range trading and then you see Bullish hidden divergence – this could allow you to jump in. In general, this type of divergence is rarer than common one. The logic that is the foundation of this divergence tells that although the indicator shows strong momentum in continuation previous move (down) – sellers are not able to push prices lower than previous lows. Usually the second bottom stops at some deep Fib support – 0.786 or 0.88. And this is tells us that the market is stronger than it seems based on the indicator.

The same is true for bearish divergence.

Pipruit: Wait a minute, Commander. Let me clarify that a bit further. Say, market in downtrend, then we should see that market creates lower highs, but indicator creates higher highs, and it means that down trend will continue, right?

The same is for up trend. Market shows higher lows, while the indicator shows lower lows – it tells that the uptrend will continue?
Commander in Pips: That’s right.

Comments

marco castro
7 years ago,
Registered user
great job Sive

great job Sive, you are teaching us real good tools
justolufemi
7 years ago,
Registered user
MACD

pls i notice that ur MACD is differnt 4rm ur i.e it show bar while urs is like two moving average line, what can i do?
Sive Morten
7 years ago,
Registered user
> pls i notice that ur MACD is differnt 4rm ur i.e it show bar while urs is like two moving average line, what can i do?

Well, you have to download another MACD, that could be visiualized as two lines.
Check in corresponding part in our School, dedicated to MACD. THere should be one to download. (look in comments below chapter itself)

Chapter 12, Part II. Moving Average Convergence Divergence - MACD. - Q&A
justolufemi
7 years ago,
Registered user
RE:macd

> Well, you have to download another MACD, that could be visiualized as two lines.
Check in corresponding part in our School, dedicated to MACD. THere should be one to download. (look in comments below..

i ve downloaded the new MACD so how i do i make it appear in my trading terminal pls help me thanks
Sive Morten
7 years ago,
Registered user
> i ve downloaded the new MACD so how i do i make it appear in my trading terminal pls help me thanks

You should copy it to Metatrader/experts/indicators folder.
Usual path as follows C:/Program Files/Metatrader (this name could be a bit different/experts/indicators

Then you will be able to add this indicator on your chart through MT4 software.
justolufemi
7 years ago,
Registered user
macd

> You should copy it to Metatrader/experts/indicators folder.
Usual path as follows C:/Program Files/Metatrader (this name could be a bit different/experts/indicators

Then you will be able to add t..

pls sir i ve downloaded the MACD and it shows on my mt4 but it doesnt work,each time i click on it,it doesnt pop-up or show on the traders terminal but it shows in the custom indecator, what shud i do? and i want to know if i can use stochastic the same way since it shows 2 MA like the MACD?
Sive Morten
7 years ago,
Registered user
> pls sir i ve downloaded the MACD and it shows on my mt4 but it doesnt work,each time i click on it,it doesnt pop-up or show on the traders terminal but it shows in the custom indecator, what shud i do..

What do you mean that it shows in "custom" indicators" so that you can't plot it? If you see it in menu and can add it on the chart - it has to work. Please, give more clarification what is wrong with it...

Now, you can't use Stochastic instead, since they are abolutely different indicators - just look at their formulas.
Hamza Samiullah
2 years ago,
Registered user
Good work

Table of Contents