Normal Bullish divergence
Normal Bearish divergence
Hidden Bullish Divergence
And a Hidden Bearish divergence.
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Divergences are used by traders in an attempt to determine if a trend is getting weaker, which may lead to a trend reversal or continuation.
Before you head out there and start looking for potential divergences, here are nine cool rules for trading divergences.
In order for a divergence to exist, the price must have either formed one of the following:
Higher high than the previous high
Lower low than the previous low
Double Top
Double Bottom
Don’t even bother looking at an indicator unless ONE of these four price scenarios has occurred.
If not, you ain’t trading a divergence, buddy.
You’re just imagining things. Immediately go see your optometrist and get some new glasses.
Divergence Trading Rule #1: YesThere must be extreme highs and lows
Divergence Trading Rule #1: NoDivergences do not work in ranging markets
2. Draw lines on successive tops and bottoms
Okay now that you got some action (recent price action that is), look at it.
Now draw a line backward from that high or low to the previous high or low. It HAS to be on successive major tops/bottom.
3. Connect TOPS and BOTTOMS only
Once you see two swing highs are established, you connect the TOPS.
If two lows are made, you connect the BOTTOMS.
Divergence Trading Rule #3: Connect successive tops or bottoms only
Divergence Trading Rule #3: Divergences do not work in ranging markets
4. Keep Your Eyes on the Price
So you’ve connected either two tops or two bottoms with a trend line.
Whichever indicator you use, remember you are comparing its TOPS or BOTTOMS.
Divergence Trading Rule #4: Focus on tops and bottoms
5. Be Consistent With Your Swing Highs and Lows
If you draw a line connecting two highs on price, you MUST draw a line connecting the two highs on the indicator as well. Ditto for lows also.
If you draw a line connecting two lows on price, you MUST draw a line connecting two lows on the indicator. They have to match!
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