subject: Divergence Trading - Why Are Divergence Patterns So Profitable? [print this page] One of the most popular ways to make money from the forex markets is to trade divergence patterns. You can spot these patterns when you use certain technical indicators and apply them to your price charts. However let me first of all explain what divergence actually is.
Divergence is simply where the price makes new highs but the technical indicator in question fails to make new highs. Similarly if the price makes new lows but the indicator you are using fails to make new lows, then this is also a good divergence pattern.
This is useful because it is basically telling you that the latest price move is running out of momentum. So therefore there may be decent profits to be had by trading any reversals that may subsequently occur.
So what kind of indicators can you use to spot these divergence patterns?
Well the most effective indicator for spotting these potentially profitable patterns is arguably the MACD indicator. This is a very popular indicator amongst the forex trading community and is very useful here as well because if the price of a currency pair makes new highs, for instance, but the MACD (and ideally the MACD histogram as well) fails to make new highs, you know that the upward move could be coming to an end.
If you want additional confirmation that a reversal could be about to occur, you can also look for divergence on some of the other indicators as well. Some of the most effective ones to use for this purpose are RSI, CCI and Stochastics.
In an ideal world you would want to see a strong sign of divergence on at least two of these indicators in order to trade a reversal with any confidence. It's also important to note that these reversal patterns are best used on the longer time frames.
You can of course use them on the 5 minute chart, or even the 1 minute chart if you so wish, but the overall success rate will not be quite as high because the intraday price movements of the various currency pairs can be quite random at times, and very hard to predict.
Anyway the point I want to make in this article is that if you want to trade possible reversals, ie generate returns when the overall trend appears to be at an end, then one of the most effective ways of doing this is to look for divergence patterns amongst some of the major technical indicators. This is because they will often tell you when the current trend is running out of momentum.
Divergence Trading - Why Are Divergence Patterns So Profitable?
