Here’s how you could trade divergences:
Divergence Type Price Oscillator Trade
Regular Higher High Lower High SELL
Regular Lower Low Higher Low BUY
Hidden Higher Low Lower Low BUY
Hidden Lower High Higher High SELL
Divergences act as an early warning system alerting you when the market could reverse. For example, if bulls have steadily pushed EUR/USD higher, the appearance of divergence between price and indicator could mean that bulls are running out of gas and price will soon fall.
Please keep in mind that I use divergence as an indicator, not a signal to enter a trade! It wouldn’t be smart to trade basely solely on divergences as too many false signals are given. It’s not 100% foolproof, but when used as a setup condition and combined with additional confirmation tools, your trades have a high probability of winning with relatively low risk.
On the flip side, I think it is just as dangerous trade against this indicator. If you’re unsure about which direction to trade, chill out on the sidelines.
Divergences don’t appear that often, but when they do appear, it’d behoove you to pay attention. Regular divergences can help you collect a big chunk of profit because you’re able to get in right when the trend changes. Hidden divergences can help you ride a trade longer resulting in bigger-than-expected profits by keeping you on the correct side of a trend.
The trick is to train your eye to spot divergences when they appear AND choose the proper divergences to trade. Just because you see a divergence, it doesn’t necessarily mean you should automatically jump in with a position. Cherry pick your setups and you’ll do well.
Ready to learn more about trading? Check out this article on finding entry and exit points.