Charting Forex with Divergence

What is a divergence and how can it be used in charting Forex effectively?

A divergence occurs when there is a discrepancy between the price, and the technical indicator used to monitor its movement.

A bearish divergence can be seen in the chart below the price makes a higher high while the RSI indicator makes a higher low (mauve lines drawn to highlight this). A "short" trade can be confidently traded once the two lower moving averages 20ma and 8ma have stacked up as required and the RSI has crossed into the bearish area.

A divergence can be defined as the failure of an indicator to confirm the higher highs or higher lows of the price.

Whenever a divergence setup is noted, we can be reasonably sure that the top or bottom is very close, and we must be prepared to get in the trade at the earliest confirmation of the trading method utilised.

In the following chart, a bullish divergence can be seen (mauve lines drawn to highlight this), price is hammering out "support" while the RSI is making higher lows

How many types of divergences are there? To concern ourselves these are the two that I would be most intrested in, the “regular divergence” described above and the second form is an “indicator to indicator” divergence.

This second form of divergence can be observed as a discrepancy between two reliable indicators, in my trade analysis this would be the RSI and Stochastic indicators being way out of synchronisation.

This can be seen in the chart below, the price has made a new low (yellow ball used to highlight position), RSI indicator has not crossed into the opposing territory, however notice that the Stochastic indicator has gone overbought and now moving up.

The RSI and Stochastic signals are not in sync and I look at this as a divergence indicating that the price is about to continue into its bullish move, trade "long" after the lower moving averages have stacked in the required order.

In the chart below the Stochastics indicator is indicating "overbought", whereby the RSI indicator is holding its position in the bearish area (blue ball used to highlight position), RSI indicator has not crossed into the opposing territory, however notice that the Stochastic indicator has gone overbought and now moving down. Trade "short" when the two lower moving averages have crossed and stacked in the correct orderIdentifying divergences when charting Forex, must be made with a conscious effort, as divergences are not always very obvious, especially when you are looking at setups on a chart at the far right side of the screen.

So how do you identify a divergence without loosing concentration on other aspects of trading?

The idea is when trading a setup, or a method shown on this site confirms a potential trade, then a quick glance to the left of the chart or a look at the position of the two indicators, should reveal if a divergence exists, if it does, this surely will add weight to the probability of the setup that is about to be traded.

A divergence is a very reliable "leading" indicator and not a "lagging" one, trade it with the techniques shown on this site

There is another type of divergence that exists and not too common when charting Forex, this is classed as “hidden divergence”

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