There are a lot of traders and many of them use divergence in their own way. Most of these ways lead to the deposit losses in the long run, because generate the late entries. I like to trade with Alexander Elder’s approach to the divergence. It has the clear entry condition and the small stop-losses in case of mistake. Divergences allows to enter the market exactly before the actual trend reverse, thus you always buy the dip and sell the rip, which produces the best risk to reward ratio. Foe divergence defining we will use MACD indicator, but you can choose any oscillator with zero-lne. After reading this guide you will be able to define divergences on every appropriate oscillator.
Let’s consider this approach!
What is bearish divergence? For the true bearish divergence we should see four obligatory signs.
(1) Point C on the price chart should be higher than point A.
(2) Point C on the MACD is below than point A.
(3) The MACD histogram have to cross the zero-line to the downside to form the point B
(4) The MACD histogram have to cross the zero-lne to the upside after the (3).
Now it’s time to find the entry point. Point C is formed when the decreasing column appeared on the MACD. (5) It is the time to execute short position. Stop loss we should take above the point’s C high. As you can see we have the very small stop loss with the huge profit potential.
Next condition enhances the short signal:
(6′) Decreasing MACD lines while the price increases.
Bullish divergence is the opposite to the bearish. We have to see the following conditions.
(1) Point C is below the point A on the price chart.
(2) Point C is above the point A on the MACD histogram.
(3) We have to see first MACD histogram crossover with zero-line to the upside to form the point B.
(4) Than we have to see the opposite crossover to the downside.
Now it’s time to wait the first increasing column on MACD histogram to spot the point C and (5) execute the long positions. Stop loss should be set below the point C low.
We can often see the price decrease continuation to the point D, this point is (6) also forms divergence, which enhances long signal, like the (7) divergence with MACD lines.
In this particular case the stop loss was not hit, but it could be the case. In this case we should re-enter position when the divergence conditions was met again.