Why does divergence work

We will discuss them one by one. So, Did you know that:. There are four Order Types in total, and here we will take a look at them and also a particular Order Type can be more profitable than the other in a particular situation. The Order Types are:. This Order Type is the basic one which gets executed when you enter the market and do not specify the price of the same.

In this case, a limit price is set for you to buy a stock. With this type, you can set a limit on the amount of funds you wish to trade. This will, conclusively, limit our losses. This is similar to Stop Loss Order but is applicable to buying of shares.

Now, the main point here is that, if you are aware of all these Order Types, then in a particular given situation of buying or selling, you will be able to pick one of the above options to place your order.

But, only in case you do not care about the speed or time, it may take for your preferred price to be triggered. And, in case you want to sell at a certain price, Stop Loss will help you do so. Whereas, in case you wish to buy at a particular price, then Stop Limit is more beneficial to avoid losses.

Hence, either to help you get more profits or to evade losses, knowing the order types is essential. You must give importance to the fact that connecting the right points on the graph depicting Highs and Lows of the actual price is of utmost importance.

There will be four things here - a previous high, a current high, a previous low and a current low. It is really important that you connect only the previous with the current High or Low as shown in the image below. Another important thing to do is to connect all the previous Highs Higher Highs or Lower Highs and previous Lows Higher Lows and Lower Lows in the actual market as well as the Indicator as is shown in the image below.

Another important point is that you must not forget to connect the verticals, which means that the points as in the Actual Market Price High or Low should be connected in the Indicator. Take a look at the image below. It has been rightly observed that the Longer Time Frames are more accurate than the Shorter ones since you get less false signals in them.

This definitely means that there would be fewer trades, but there are more accurate signals, and if you plan the trades well, you can gain much more in such a scenario.

Shorter ones, on the other hand, are less reliable. For instance, one-hour charts or even longer than that can play the trick for you. It has been also seen that entering the market too early can lead to losses. And, in case you enter the market too early too often, it can lead to huge losses. But, you are making use of Divergence Trading to make profits and not losses. In this scenario, you must remember these points:.

You must wait for the Indicator crossover since it indicates a potential shift in the momentum. This implies that there can be a shift from buying toward selling or from selling toward buying after the crossover happens. This is shown in the image below. Secondly, you must wait for Indicator to be out of oversold or overbought category since if it stays in one of them for a long period of time, it may not be able to indicate a reversal accurately.

Refer to the image below for understanding the same. As we read about the Types and Oscillators of Divergences above, we understood the importance of each correctly. But, now what remains is to know how to use them in trading?

Basically, Divergence helps the trader recognize a potential change in market price and also, helps to make appropriate trading decisions on the basis of the same. Let us find out how you can use Regular and Hidden Divergences alongwith their Oscillators in making the trading decision. As we saw earlier, a Regular Divergence plays quite an important role in finding out when a trend reversal is expected to occur. Seeing Convergence-Divergence with MACD oscillator, we know that Convergence means trend is likely to continue and Divergence means trend reversal is more likely to occur.

Regular Bearish Divergence is noted when the actual price in the market makes Higher Highs but the Indicator makes Lower Highs downtrend. In Regular Divergence, the oscillators indicate the momentum shift and thus, point toward a reversal of the trend. This implies that observing the Divergence helps to know that the end of a trend is expected. But, we have already mentioned but would again emphasize on making use of other factors as well to confirm if the trend reversal or ending of the trend is actually going to happen.

With the passage of time and practice, you will be more proficient to spot divergences in real-time and to capitalize on them. In order to make better trading decisions, it is crucial to understand how to spot the divergence. Having that understood, you can move on to learn about the divergence trading strategies. Setting right and prudent profit targets is another div strategy that can help to get better returns on divergence trading.

One common method to set profits is to create a trend line. Divergences are one of the most important and commonly used concepts in technical analysis. It simply mean the non-synchronization between the indicator and the price action.

Divergences indicate many things such as it indicates positive or negative movements in the stock prices. Regular divergences and hidden divergences are the two categories of divergence. Regular divergence further divides into regular bullish divergence and regular bearish divergence. Similarly, hidden divergences include hidden bullish divergences and hidden bearish divergences.

A chart working on two variables at least is the requirement to spot divergences. There are several indicators like relative strength index RSI that also help to identify divergence.

However, it is absolutely imperative to be patient and only enter the trade upon confirmation. Alternatively, it could also be considered a divergence if for example the stock price of two companies in the same industry moves in different directions. If you spot such a situation, it could be worthwhile taking a closer look at what is really going on.

The four red lines in the chart below represents divergences between the Relative Strength Indicator RSI and the price. Notice how the price continues to make new highs, while the RSI at the same time fails to make another high.

As a result, we got a divergence between the trendlines on the price and the RSI — an amazingly accurate predictor of a change in market direction that you should pay attention to!

If we stick with the RSI vs. In short, the divergence below shows us that the strength of the prevailing price movement is decreasing. In both cases shown above, we can see that the vertical distance between the tops in the market has decreased, confirmed by the downward trendline on the RSI.

In other words, the bulls are running out of steam and are about to get exhausted — a clear sign that sellers are about to take the lead in the market. To spot a divergence, you need a chart that shows at least two different variables. To start with, I suggest going with the same set-up as our example above; price and the RSI indicator. Quickly scan the RSI and look for situations where it reversed from an uptrend to a downtrend, or vice versa.

Every trader knows this scenario: you found a great setup and entered a trade, then price goes against you and. How To Trade Candlestick Wicks. Candlestick wicks are among the most commonly misunderstood and misused concepts of technical analysis there is. Whereas conventional pinbars are straight-forward. Whether we look at strong price turning points, trends or support and resistance areas, the concept of supply and demand. Price Action Course Video — Complete course. At the core of every price analysis, price action is the most important factor.

In this special video, I am. Comments 25 Daniel. Good article. You got a missing picture in the page.. Simplistic and usefull info thanks once again. Great piece of information…. God bless great teacher like you, good article from you, keep it up Thank. Excellent and on point article. Great article Rolf, and great examples, Thank you. Thanks for sharing! One of the best way to enter a divergence is when rsi breaks level Thanks a trillion for enlightening me.

Very useful divergence trading tips. I always cherish your articles.