Professional traders say that divergence is a profitable strategy after the Price action trading strategy. Here we talk about the Stochastic divergence best Divergence trading
If we try to understand in lam and terms So divergence is a complete trading system.
With the help of divergence, you will be able to determine the trend will continue or reverse. In Technical language, we can say Stochastic divergence is a high probability of price retracement.
What are the indicators?
All analytical indicators on stock exchanges are built on various mathematical or geometric algorithms and perform some calculations, after which they display- the results in the form of graphic formations that can be displayed in the form of histograms, sliding, as well as other displays of price behavior.
All the data that the indicators display are later used for technical analysis, based on which orders are opened in the direction of a particular position.
Stochastic Divergence indicators
Today we will talk about one of these methods for analyzing the price chart which is based on the classic stochastic oscillator but the signals that we will consider today are based not on the usual version of the intersection of overbought and oversold zones, but on identifying such a formation stochastic divergence.
Based on the logic of what we have described above, we can make the following:
The assumption that working according to the Stochastic indicator, the price maximum values of the indicator should correspond to the maximum quote values,
While the same should happen with the minimum peaks, all the minimum quote values should correspond to the minimum values of the indicator.
The whole point of indicators is that they can only find probable formations, and not exact once, so it often happens that the maxımum price peak will not correspond to an increase n the peak on the indicator curve, It can be both below the maximum peak of the curve, and on par with him.
How to identify divergences?
Thus, The price divergence is obtained which is expressed in different readings of the indicator and the price itself. Probably at first, everything looks a little complicated, But take my word for it, as soon as you grasp the essence, You will understand that there is nothing complicated in this, and of course, we will back everything p with examples so that you can see.
how to identify divergences. But for now, let’s figure out what best of divergences exist.
Six Types of divergences
Personally, I know only six types of different variations of divergences, let’s list them;
1. The stock quote draws consecutive lows, while the indicator draws non-declining low peaks or they are located at the same level.
2.The stock quote draws sequential maximum values, and the indicator draws non increasing values or they are located at the same level.
3. The stock quote does not draw consecutive decreasing lows, but the indicator draws non-declining highs.
4. The stock quote does not draw consecutive rising highs. But the indicator does not draw rising lows.
5. The exchange quote draws a repeating high, but the indicator does not draw.
6. The exchange quote draws a repeating low, but the indicator does not draw.
Let’s move on to specific examples that are displayed on the chart, so it will be much easier to understand the whole essence of the Stochastic divergences instrument.
1st and 2nd Variants of divergences for the Stochastic instrument
That the first and the second point of Stochastic divergences warn the speculator that soon the quote will make a reversal, of course, such a signal is not one hundred percent.
But only highly probable, but in fairness, it should be noted that such a signal is considered very strong in technical analysis and it is much more effective than several other signal variations.
Thus, you can make the following cheat sheet;
1. In the first scenario, it can be argued that the upward trend is becoming weaker, and the “bears” are likely to make a price reversal
2. In the second variant, it can be argued that the downtrend is becoming stronger, and the bulls are more likely to reverse the trend to an upward
Let’s give an example of the first option on the chart, the figure below reflect this picture as best as possible;
An example of stochastic divergence by stochastic Oscillator variant 1 and variant 2.
We marked the rising highs with the green diagonal line, the vertical white lines marked the moment when the divergence was detected.
The red diagonal marks the moment of lowering of the highs on the Stochastic indicator, thus the divergence of prices and indicator readings are obtained.
From a logical point of view, it all looks like the bulls made a last-ditch effort, while the indicator did not reveal a price increase with past values, that is it tells us that the bulls no longer have the strength to push the price up.
As we can see, the signal worked perfectly well and later the price turned
around and went in the direction of the given signal. At the same time, the
price did not just roll back but passed a decent distance, which resulted in several dozen candles.
Divergence for the Stochastic 3 and 4 indicator
These types of divergences tell the trader that a highly likely continuation of the trend could occur in the market. Thus, we can conclude that
1. The third option will inform the speculator that the downtrend will continue
2. The fourth option will inform the speculator that the uptrend will continue
The figure below shows the fourth version of the divergence display, the green diagonal marks yes consecutive rising lows, and the red diagonal marks the minimum consecutive peaks on the Stochastic indicator.
With two yellow vertical lines, we marked the moment when the diver was formed.
An example of the third and fourth variants of divergence by Stochastic Oscillator.
It can be seen with the naked eye that the minimum peaks of the quotes are growing.
and the minimum peaks of the stochastic are telling. based on this, it is possible to
assume with a certain degree of probability that the price will continue its upward movement, which happened n the future.
Although divergence is considered a rather strong signal, all our options,
compared to those that will be lower are considered weaker so it is best,
before opening order, to find confirmation of these signals by any
filtering instrument, for example, it can be some kind Any horizontal level or
The simple moving line that indicates the direction of the global trend
5th and 6th option. Stochastic Divergence indicator
This type of divergence is considered the strongest of all of the above, its formation on the
price chart informs the trader that a strong horizontal level has formed, thus the
addition of two signals is obtained, in the first case it is a divergence, which is strong itself, and in the second case, the level, which is also not unimportant in trade.
The 5th divergence option will inform the trader that a strong horizontal support level has formed in the market, from which the price will reverse with a high probability.
The sixth divergence option will inform the trader that a strong horizontal
resistance level has formed 1n the market, from which the price can also reverse with a high probability.
Let’s look at the sixth divergence option in the chart below;
example of stochastic divergence by stochastic Oscillator 5 and 6 examples
With the green horizontal straight line, we marked a strong resistance level, which was formed by two identical quotation maximum values, the white vertical bars mark the time range of this formation, the red diagonal marks a decrease in the maxımum peak values on the Stochastic indicator.
The discrepancy between the price and the instrument readings immediately catches the eye, fin the case of the quotation the price peaks do not rise or fall, then the Stochastics already screaming that the advantage is going to the "bears". The ideal entry point, of course, will be the level, moreover, by opening an order according to this principle, your stop loss will be additionally protected by orders of other traders who also trade from the levels, as we can see. In the future, the price worked out the signal perfectly and we made money on it in decent condition.
I would also draw your attention to the fact that after the second maximum peak value was formed, the price fell like a stone, this indicates that large volumes came to the market.
Let’s sum up
Let’s summarize, I personally really like divergence and always use it when analyzing a price chart, only I like working with a diversion not according to Stochastic, but according to the no less famous MACD indicator.
No, I’m not saying that it is not profitable to work with Stochastic or it does not work well, in any case. the fact is that the MACD indicator is more clear to me.
Most Important Divergence Types
Divergence occurs when a market makes a high high on a chart and an indicator that strictly follows it does not display that high high, but instead makes a lower high! This indicates that the market has weakened and that there is a high probability that the price could reverse in the near future. It can be a correction or a market reversal.
The divergence in the above example is called the classic bearish divergence.
A similar situation can appear in a falling market. If the market marks lower lows, the indicator also displays lower lows. If there is a discrepancy between the price chart and the indicator, a possible change in direction is assumed. (See picture below)
The divergence defined above is called the classic bullish divergence. The term “bullish” refers to the direction of the price chart that the market will follow after a divergence.
“Bullish”, if the market goes down, then it will go up.
“Bearish”, if the market goes up then it will go down.
Best Divergence Types
- Classic or regular divergence
- Hidden divergence
- Extended divergence
regular or Classic divergence is the most common; it occurs when a trend reversals.
Hidden divergence is known to approximately 25% of forex traders who use conventional divergence. Hidden divergence is a sign that the trend is continuing.
Extended divergence is also a sign of a trend continuation. Few people know about this type of divergence. However, it is a powerful signal that can be used in trading.
Divergence does not happen very often, however, if it does, pay attention to it.
Classic divergence will help you make substantial profits from the market as you enter at the very beginning of a trend.
Hidden divergence will help to stay in the direction of the trend longer and take more profit than planned, as it will indicate that the trend is continuing.
Regular divergence is a type of divergence that signals a possible price reversal in the forex market and can be a signal to open a long (buy) or short (sell) position.
Classic bearish divergence indicates that the price is about to go down, be prepared to sell.
A classic bullish divergence indicates that the price is about to go up on the chart, be prepared to buy.
Classic bearish divergence:
It occurs when the second peak on the price chart is higher than the previous one, and on the indicator the second peak is lower than the previous one. If you draw a line between the peaks, then on the chart it is directed upward, on the indicator – downward. This is a signal for a possible downward movement that can be used to open a sell position.
Classic bullish divergence:
It occurs when the second bottom on the price chart is lower than the previous one, and on the indicator the second bottom is higher than the previous one. If you draw a line between the troughs, then on the chart it is directed downward, on the indicator – upward. This is a signal for a possible upward movement that we can use to open a buy position.
Classic bullish divergence
Hidden divergence is a divergence that signals a trend continuation and is harder to see. Very few traders know about its existence. Like a regular divergence, a hidden divergence can be a signal to open either a long or a short position.
Hidden bearish divergence suggests that the charge chart maintains to go down.
Hidden bullish divergence suggests that the rate chart maintains to head up.
Hidden bearish divergence
It occurs when the second peak on the price chart is lower than the previous one, and on the indicator, the second peak is higher than the previous one. If you draw a line between the peaks, then on the chart it is directed downward, on the indicator – up. This is a signal for a possible continuation of the downward movement, which we can use to open a sell position.
Hidden bearish divergence
Hidden bullish divergence:
It occurs when the second bottom on the price chart is higher than the previous one, and on the indicator the second bottom is lower than the previous one.
If you draw a line between the troughs, then on the chart it is directed upward, on the indicator – downward. This is a signal for a possible continuation of the upward movement, which we can use to open a buy position.
Latent divergence is sometimes compared to a catapult. The point is that the indicator acts as a catapult – after a slight correction, the market will catapult in the same direction in which it moved earlier. The indicator displays a slight pullback. This is a good signal to enter the market.
An extended divergence is similar to a regular divergence, however, in this case, the price movement chart paints a pattern very similar to a double top or double bottom.
Along with the fact that the second top (or bottom) on the price chart is at the same level or slightly higher / lower than the first, the indicator draws a second maximum (or minimum) at a different level, which is significantly higher or lower.
This prolonged interpretation of marketplace conduct suggests that the marketplace keeps moving in the identical route.
You will see it every time at the bottom of a powerful market movement, at the moment when the market begins to think about stopping its movement.
Instead of changing direction to the opposite and instead of forming a consolidation pattern, the market will continue to move in the same direction.
Extended bearish divergence indicates that the price chart continues to go downtime to sell.
Extended bullish divergence indicates that the price chart continues to move up – time to buy.
Extended bearish divergence:
It occurs when the second peak on the price chart is at the level of the previous one, and on the indicator, the second peak is significantly lower than the previous one.
If you draw a line between the peaks, it will be flat on the chart and down on the indicator.
This is a signal for a possible continuation of the downward movement, which we can use to open a sell position.
Extended bullish divergence:
It occurs when on the price chart the second bottom is at the level of the previous one, and on the indicator, the second bottom is significantly higher than the previous one.
If you draw a line between the troughs, it will be flat on the chart and upon the indicator. This is a signal for a possible continuation of the upward movement, which we can use to open a buy position.
IT IS IMPORTANT TO KNOW:
- The troughs and peaks on the chart and indicator must be in the same time frame. For example, if the peak on the price chart on the 4-hour chart falls at 12-00, then the peak on the indicator should also be at 12-00.
- Divergence is only confirmed if the slope of the line connecting the tops/bottoms of the indicator differs from the direction of the slope of the line that connects the price tops/bottoms. The slope must be one of the following: Ascending (Ascending), Descending (Decreasing), Flat.
- If you have identified a divergence, but the price has already reversed and moved in a certain direction for some time, then the divergence should be considered completed. This time “the ship sailed away”. All that can be done in this case is to wait for the formation of another wave of tops/bottoms and then start identifying the divergence from the beginning.
- Divergence on long time frames is more accurate. Fewer false signals. You also receive fewer signals, but the potential for profit is huge. Divergence in small time frames happens more often, but its signals are not as reliable. We recommend looking for divergence on an hourly chart or higher. Some traders use this tool on 15-minute charts or even smaller ones. However, there is a lot of noise on these timeframes, so it is best not to work on them.
- To make it easier, we suggest downloading the Divergence Panel indicator, which can automatically find the formation of divergence on all currency pairs and display all data in a single panel window.
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