October 6, 2013

A Guide to Divergence Trading On the FX Rates Market

FX Rates Divergence

Before entering the foreign exchange live market, it is highly recommended you undergo some foreign exchange training.  This is not only to ensure you know what the market is about but also what your role is as a trader.  In order to become an effective trader on the foreign exchange market you must have a strong trading system and this can only be obtained by having a strong, working knowledge.

When going through forex training you will see that there is a plethora of different forex strategies available to you.  It is important to determine what is most suited to your personality and trading requirements before choosing one.  There is no point in using a strategy you aren’t comfortable with, it will only lead to losses.  One of these strategies is known as divergence trading.

What is divergence trading?

It is impossible to incur a profit with all trades as the market can easily swing turning your good trade to a bad one.  However, there are methods to reduce the risk of loss and increase the chance of profit – every trader’s aim.  One method is that of divergence trading.

Divergence trading is a low risk method of comparing price movements against the movements of a trading indicator.  For example, you will be able to sell at the top of a trend or buy at the bottom of it.  Another example is exiting a trade at the correct moment if you are aware of future movements in a long-term position.  When used adequately, a divergence FX rates trading strategy could help you experience numerous profits.  This strategy has been used by many as a means of spotting weakening trends and/or reversals that are in motion.  There are two basic types of divergence trading which are listed below.

1. Regular FX rates divergence trading

The regular divergence trading strategy is used as a sign for trend reversal.  If the currency is showing lower lows but an oscillator is indicating higher lows this will be considered a bull divergence.

This bull divergence will generally occur at the end of a downtrend.  Once a second bottom is identified and the oscillator does not show a new low then the currency price should increase.  This is due to both the currency price and momentum being expected to move simultaneously alongside each other.

However, if the currency price is seen at a higher high and the oscillator is at a lower high then a bearish divergence is evident.  This type of divergence is seen during an uptrend.  Once the price hits a second high and the oscillator drops you will more than likely see a reversal and decline in the currency price.

2. Hidden FX rates divergence trading

The hidden divergence trading strategy is used as a sign for trend continuation.  When a hidden bull divergence occurs the currency price presents with a higher low despite the oscillator showing a lower low.  This generally occurs during an uptrend.  However, if the price and oscillator follows a higher low and not a lower low then this is known as a hidden divergence.

A hidden divergence in a bear condition occurs when the currency price hits a lower high and the oscillator a higher high.  This is shown during a downtrend.  The hidden bearish divergence occurs when both continue on a lower low path.



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