How useful is Divergence?

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#378: How useful is Divergence?

In this video:
00:25 – Most indicators do not work
00:52 – Trader who joined in 2012 appreciates how good Divergence can be
01:45 – How I use Divergence
02:21 – The 2 types of Divergence
03:05 – My favourite type of Divergence
04:48 – What are we looking for?

Divergence. Is it really a useful tool as a Forex Trader or is it a gimmick? Let’s talk about that more right now.

Hi, Forex traders, Andrew Mitchem here at the Forex Trading Coach with video and podcast number 378.

Most indicators do not work

Now I want to talk about a really, really special type of indicator. Now as you probably know, I’m not a fan of almost all indicators. I use horizontal levels, but I’m not a fan of different moving averages and things like that. And all the indicators that the Forex brokers constantly throw at you with most platforms that you can get, there’s hundreds and hundreds of different indicators that you can find.

Trader who joined in 2012 appreciates how good Divergence can be

And I want to tell you a story about a client of mine, who back in 2012 joined me. And he’s done extremely well from his Forex trading, but he said to me, the other day we had a chat and he said, “Look, Andrew, I just wasn’t aware of how good divergence was when you mix it in with all the other things that I’m looking at and I teach as part of my course in my trading strategy.”

And he said, “I understood certain things about price action and pivot points and candle patterns, but I just didn’t appreciate,” and it took him quite a while to appreciate. It was only when he saw lots of examples and put it into practise. He didn’t appreciate how good divergence can be if you use it the way that I use it. And if you use it correctly. So with that in mind, when he added that to his trading, his trading just increased another level again.

How I use Divergence

Now I don’t use divergence just simply as there’s a positive divergent signal, therefore I’m taking a bite. Don’t do that at all. I’m using it to back up what I see with my price action trading and my candle stick analysis and my strength and weakness and bouncing off brand numbers and all that type of thing that I look for anyway.

But if I get divergence at the same time or just a little bit before my candle pattern, then that gives me an added boost, an added bonus to say, yes, this is a high quality trade.

The 2 types of Divergence

Now with divergence, what are we looking at? Well, for me, there’s two different types of divergence. There’s regular divergence, and that’s indicating to me a reversal. So we have an uptrend, we get regular negative divergence, and then we’re likely to get a downtrend, a reversal. Likewise, we’re in a downtrend already, we get regular positive divergence, the trend generally turns around and moves up. Now, as you’d know from previous videos and podcasts, I like reversal traits, but they’re slightly higher risk. You know, you are trading against the main direction at the time. So you need to have a very strong pattern, very strong setup in order to justify taking a trend reversal.

My favourite type of Divergence

But my favourite type of divergence is, and there’s a lesser known type of divergence, it’s called hidden divergence. And that hidden divergence to me is when the price action is at a certain part of the chart. And when I see that happening, it’s a trend continuation pattern. And that to me is a highly strong, high probability, high quality trade setup, because it means I’m trading with the trend, but after a retracement. So in other words, if I see a hidden positive divergence, I’m seeing an uptrend and then a pullback. And then I’m seeing my candle pattern all in a certain part of the chart again, which I trade and I teach, all happening for a reason with the hidden positive divergence. That gives me the confidence to take the bullish trade, the buy trade, for the price to then start moving back up again.

Likewise, in a down trend, we then see a pull back again to a certain level. And then we see the bearish set up with the hidden negative divergence looking for the trend to continue down again. So the continuation patterns are certainly the higher probability traits. The reversal patterns on your charts look really cool because you’ve taken a sell trade right at the top of a trend or a by trade right at the bottom of a trend and in hindsight, when you see a reversal trade work, it looks fantastic. But always come back to that higher quality, higher probability set up of the continuation patterns will give you a higher win rate and a higher probability of success. Although the reversals can be very, very good.

What are we looking for?

So what is it that we’re looking for with divergence? So with negative divergence, we’re looking for the highs in the indicator to fall as the highs in the price get higher. So that becomes our conflict, our divergence. And so with that, we’re looking for the price to fall. With hidden divergence, we’re looking for also the indicator to fall, but this time we’re looking for the lows in the indicator to get lower. As the lows in the price have got higher, that’s a hidden positive divergence signal this time, which gives us the indication that the trend is likely to continue up. So two different types of divergence. One’s regular, one’s hidden. One’s for reversals, the other’s for continuation patterns. Two very different patterns, but two very, very high quality patterns that will certainly assist you with your trading.

So I hope that helps. If you have any questions, just like that question about divergence, send me an email, [email protected] And I’ll see you here this time next week for another video and podcast.

Episode Title: #378: How useful is Divergence?


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