Every day, a trader, in his or her early days, has losses. A large reason for this is not correctly spotting divergences because they are key signals of an imminent trend reversal or continuation.
In this article, we will take into account what is divergence trading best strategies, one of the charting platforms that is in use—TradingView. The Relative Strength Index (RSI) indicator will be used in order to identify divergences effectively.
With a good grasp of the concepts behind regular and hidden divergences, a trader can greatly enhance trade entries, hence increasing the probabilities of nailing it right. This article will take you on a step-by-step process to first set up your charts correctly to identify the divergences and, second, how to enter a trade based on these powerful signals.
Interpreting Divergence
What is the Divergence
Divergence means the asset’s cost moves in an opposite direction in relation to some technical indicator, which is normally the RSI. Divergences may signal a reversal of a trend or trend continuation in a market, and this makes the indicator indispensable for traders.
Divergence Categories
Regular Divergence: Indicates possible reversal of a trend.
- Bullish Divergence: In this scenario, the price action is at a lower low, while in the corresponding RSI scenario, the two are. Divergence: higher high in price but a lower high is recorded in RSI.
- Hidden Divergence: It is indicative of potential trend continuations.
- Bullish Hidden Divergence: Price makes higher lows, but the RSI indicator makes lower lows.
- Meaning: Hidden bearish divergence is when price moves to make the higher high, but the RSI makes the lower high.
Setting Up Your Charts
Employing TradingView
Sign up on TradingView and configure your chosen asset chart for an hourly time frame. Apply the RSI indicator as follows:
- Click on the “Indicator” tab.
- Search for “RSI” and select the embedded Relative Strength Index.
- Adjust the parameters to length 14, for both the upper and lower bands use the value 50, and then to your liking, choose the RSI color.
Adapting RSI Settings
- Character: 14
- High Band: 50
- Lower Band: 50
These settings would be useful to keep you focused on momentum, as opposed to the standard overbought/oversold settings.
Identifying Divergences
Regular Bullish Divergence
Bullish divergence commonly appears in the form of price making lower lows, and the RSI is making higher lows, indicating a possible trend reversal to the upside.
Example:
- Lower low is made by price.
- RSI here makes a higher low.
- Wait for a strong rejection candle before entering a position.
- Go long with stop loss at the recent low.
- Aim for a risk-to-reward ratio of 1:2.
Regular Bearish Divergence
Normal bearish divergence takes place when the price is hitting higher highs, but the RSI is hitting tops that are lower highs, indicating a possible downside trend reversal.
Example:
- Prices make a higher high.
- There is a lower high on RSI.
- Wait for confirmation in the form of a strong rejection candle.
- Sell short with a stop loss above the recent high.
- Always have at least a 1:2 risk-to-reward.
Hidden Bullish Divergence
A bullish hidden divergence is a positive divergence continuation of a bullish trend. It occurs when an ETF has higher lows but an RSI with lower lows.
Example:
- Price makes a higher low.
- RSI makes a lower low.
- Look for one strong bullish candle to confirm the entry.
- Go long with a stop loss below the recent low.
- Establish a 1:2 risk-to-reward.
Hidden Bearish Divergence
Hidden bearish divergence signals that a continuation of the downtrend is coming. It occurs when the price forms lower highs, but the RSI is forming higher highs.
Example:
- Price makes a lower high.
- RSI creates a higher high.
- Search for a very nice bearish candle for confirmation of entry.
- Go short with a stop loss above the recent high.
- Target a reward/risk ratio of 1:2.
Real-World Application
Trades Example
Regular Bullish Divergence: Euro
- Trade: The chart of $SETI in Figure 3 is an illustration.
- Stop Loss: At the previous lowest low level.
- Take profit: At 36 pips (1:2 risk-to-reward).
Hidden Bullish Divergence: Australian Dollar/US Dollar
- Open: At the close of the confirmation candle for a long position.
- Stop Loss: Below the recent low.
- Take Profit: 41 pips (1:2 risk-to-reward).
Classic Bearish Divergence: German 30 Index
- Entry: Goes short one tick below the confirmation candle.
- Stop Loss: Placed above the recent high.
- Take profit: 100 pips (1:2 risk-to-reward).
Hidden Bearish Divergence: US30
- Entry: At the confirmation candle close: short.
- Stop Loss: Above the recent high.
- Take profit: 321 pips.
Conclusion
Mastering this divergence trading strategy would become a very important key to a performance improvement, as it gives you a high-probability entry point. Knowledge of the regular and hidden divergences market turn and continuation in the trend that follows will similarly be improved, therefore increasing overall profitability.
It helps a lot to include this strategy in the trading plan, while a regular practice will give a big jump to trading performance. Construct divergence as your tool—it should give light to deeper revelations concerning market moves, hence continued profitable exploits on your trading efforts.