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A divergence occurs when a financial asset continues to rise or decline
contrary to a technical momentum indicator. To bypass common trading
mistakes, it is imperative to know how do the professional traders trade
divergence.
Image: showing divergence samples
Types of divergences
1/ Bullish divergence
It takes place while a financial security
continues to weaken, but momentum oscillators such
as MACD, RSI, CCI or stochastic indicator become bullish.
See the chart
Image: 3-Minute chart showing a MACD
bullish divergence of Dow Jones Industrials.
2/ Bearish divergence
Contrary to the bullish divergence,
it happens when a financial asset
continues to rise at the moment
when the stochastic or any other
momentum indicator turns bearish.
See this chart
Image: 30-Minute chart showing a prolonged
MACD bearish divergence for NASDAQ 100.
3/ Discrepancies (another divergence)
Discrepancies are unusual divergences that correlate to the price's speed in
comparison to a momentum indicator's.
In this occurrence, either the price or a momentum indicator is faster than the other
even though both are moving in the same direction. Really, there is a divergence
between the two speeds. One is faster than the other.
This event is quite notable particularly if one is applying the Commodity Channel
Index (CCI indicator).
See the chart
Image (below): A weekly chart showing a discrepancy (divergence) between a faster
CCI indicator period 30 and slower Dollar-Yen currency pair (attention to
green vertical line on the chart)
Notice that the CCI oscillator went quickly too far away from the center line
after the price broke a bearish trend line. On the other hand, the price did
not deviate too far away from the red moving average 30. This was a bullish discrepancy.
Day or swing traders would give priority to bullish signals above the turquoise horizontal
line. Though a bullish trade setup alert was in place, one would wait until a clear-cut
trading signal is fired above the turquoise line. [Author = George Beaulieu]
Divergence technical analysis
A bullish divergence is a notification that
alerts day or swing traders about a
potential reversal at the end of a bearish
trend or progress. Just the opposite to
the prevailing opinion, it is not a
trading signal but a trading setup.
One must perform a top-down
trading strategy instead of racing to
buy the financial asset without a firsthand trading signal.
It is reasonable to dissociate a trade warning from trade signal to keep away from
trading errors.
Similarly to the bullish divergences, bearish divergences alert day or swing traders
about a likely reversal hot spot trading zone at the end of a bullish trend or impulsive
wave. The alarm does not guarantee that the financial security will turn around. Day
and swing traders will acknowledge the warning without ordering a premature bearish
trade. Financial market traders and investors ought to view a bullish or bearish
divergence as a hint, but they will only buy or sell financial assets after the price
reinforces it.
See this video
Title: How To Trade MACD Divergence Like An Expert
Authorship: This article is written by George Beaulieu
founder of stochastic-macd.com
How do the pros trade bullish divergence
Beginning from the reality that a divergence is a warning, not a signal, a disciplined
professional day or swing trader will only buy after the price is out of the bearish
channel and gain a support.
Surely, one is not trading the indicator but the price. Consequently, if the price is
still in a declining channel, one should not set buy orders. It is cautious to wait until
a credible support is secured, or the financial instrument manifests the first higher
low above the declining channel.
In every case except on the entry time frame; a professional trader will always
consider a bullish divergence as a trading setup. Subsequent, he or she will switch
from the setup time frame to signal period before opening the trade at a low-risk
entry point.
How does a pro trade bearish divergence
A bearish divergence takes place while the price is still in a rising channel.
To dodge common trading mistakes, a professional trader who recognizes a bearish
divergence on the daily chart, will turn to the hourly chart and anticipate the price to
burst above plus retest the declining channel. In that situation, the hourly chart is
the signal time frame, yet the daily chart is the setup time frame.
He will further shift to a quieter time like the fifteen-minute chart to start the trade.
Divergence: final point
To trade divergences like a professional trader, it is vital to apply a multiple time frames
trading method (trading drill or top down trading).
First, one will notice the divergence (bullish or bearish) on the setup or higher time frame.
Alongside, one will await a signal on another time frame without infringing the market
patterns.
By the Same token, in the end, one will insert a trade at a low-risk entry spot.
Supposing that the trading signal fails, one will swiftly cut losses without blinking.
Any divergence is a non-confirmation trade structure that entails extra confirmation before
one can buy or sell a financial contract. Besides divergence speculation, one can not
gain consistent profit if one dismisses specific fundamentals. [Author = George Beaulieu]
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