Divergence can help you spot potential tops and bottoms in the market as well as give you clear view of when to take profit in an existing trend. Divergence is done by using a price chart and looking at price action and then looking for it to diverge from a momentum oscillator and here, we will look at divergence trading in more detail and how, you can use it in your currency trading strategy.

Divergence is simply price action, measured and compared with a momentum oscillator indicator. It doesn't really matter which oscillator you use, the concept is the same for all and popular ones you can use are - RSI, Stochastic, MACD, CCI, ADX – there are of course many others but these ones are frequently used.

Low Risk High Reward Trading

The great thing about divergences is that you can use them as a leading indicator, to enter and exit trading signals to enhance profit potential. When traded properly, you can be consistently profitable with divergences. The best thing about divergences is that since you’re usually buying near the bottom or selling near the top, so risk is low and profit potential tends to be high.

The Concept of Divergence

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If price is making higher highs, the oscillator you are using should also be making higher highs. If price is making lower lows, again the oscillator you are using should also be making lower lows. If they are not, this means price and the oscillator are diverging from each other. Hence the term, divergence.

When the price is making higher highs and momentum diverges you can look to take a trading signal in the opposite direction to the price or lock in profit if you are trading with price.

Trading Divergence

All traders have their own strategies for trading divergence and below I will out line some rules which I Use to trade divergence.

Divergences in longer time frames are more accurate than in short time periods which give you numerous false signals. You should not use hour or minute charts, as you are simply trading the noise of the market, taking low odds trades and will lose.

You will also get less trades in longer time frames but your profit potential is far better. Because you will trading with the odds and with better risk reward.

Generally in a currency pair the best trading signals will tend to come from when an indicator turns up from oversold levels or down from overbought levels and the more overbought or oversold the market is - the better in terms of the odds of the trading signal being correct.

I like to use overbought and oversold divergences, in swing trading and also in long term trend following, to either lock in profit or to look for contrary trades, if other indicators confirm a trend change is at hand.

If you want to be a successful Forex trader, you need to understand and trade divergence but the good news is the concept is easy to understand and all the indicators you can use, are easy to understand and apply.

We will discuss divergence using some of the most popular momentum indicators individually in other articles.