Divergence is a concept and trading strategy that is common for almost all Forex markets. It shows how the market behaves based on the price changes.
Typically, it is represented by such indicators as MACD or RSI. Divergence can be seen when the market shows a high maximum, and the oscillator displays a lower maximum.
Depending on the trend, there are three types of Forex divergence:
Each type may be classified as bullish (which predicts a trend reversal upwards) or bearish (which predicts a downward trend). In addition to that, regular divergence can be divided into 3 classes: A, B, and C. They differ depending on price and indicator discrepancies.
Regular divergence indicates a possible trend reversal. Hidden and extended types indicate a continuation of the trend.
Ordinary type is divided into bearish (the price is about to fall, so a trader needs to prepare for the sale) and bullish (the price is ready to go up, so a market player needs to prepare for the purchase).
An example of the usual bearish divergence is an increase in the height of the second peak on the chart, and its decrease in the indicator indicators. When we draw a line between them, we see the following picture: on the graph, the divergence line goes up, that is a factor of the downward movement and indicates the possibility to open a sale.
When considering the ordinary bullish divergence, traders analyze the position of the bottoms on the chart. When we draw a line, on the chart it is directed downwards, and upwards on the indicator, that signals the opportunity of buying a position.
Hidden divergence is used less frequently than the regular one. Meanwhile, the tool is more reliable, as it implies a continuation of the trend, which means that it is easier to confirm with indications.
Bullish divergence keeps the uptrend, as evidenced by the indications. Firstly, the price tends to high lows. Otherwise, there is a continuation of the downward trend. When the price is active, reaching high lows also indicates an increasing trend movement. If the indicator shows lowest price values, it is a characteristic of a hidden divergence. Traders should open long, buy an asset, set up a small grid of orders for effective transactions and follow the trend movement.
This type of divergence is a great tool in entering the trend. On the other hand, the use of this factor will not give full results as it cannot be used as a separate trading strategy, but only as a part that helps determine the stop loss and make profit.
The best option would be to use hidden divergence on large timeframes: the larder timeframe, the longer the trend movement will be over a specified period of time.
Advanced divergence in Forex is similar to regular divergences, but the indicators appear as a double top or bottom. If the second one is slightly different in the chart, this deviation will be displayed more expressively on the indicator, i.e. the second maximum and minimum value will be higher or lower than the initial level. It allows giving an extended interpretation of changes and emerging trends, which confirm the steady trend movement in the current direction. Such a situation arises when the market intends to stop the movement, but eventually does not do this in order to maintain the course.
This type of bearish divergence is described as a decrease in new peaks relative to the previous ones in terms of the indicator.
When we draw a line for a bullish type, we get a straight line on the chart, and on the indicator a segment is directed upwards. We see this and are preparing to make a purchase.
Divergence is one of the most powerful elements of the analysis, but a trader should rely not only on Forex divergence chart but consider other indicators.