Divergence Trading

The best thing about divergences is that since you’re usually buying near the bottom or selling near the top, your risk on your trades are very small relative to your potential reward

Divergence is basically price action measured in relationship to an oscillator indicator. It doesn't really matter what type of oscillator you use. You can use RSI, Stochastic or MACD.

Just think “higher highs” and “lower lows”.

If price is making highs, the oscillator should also be making higher highs. If price is making lower lows, the oscillator should also be making lower lows.

If they are NOT, that means price and the oscillator are diverging from each other. Hence the term, divergence.

There are TWO types of divergence:

1. Regular
2. Hidden

Please keep in mind that I use divergence as an indicator, not a signal to enter a trade! It wouldn't be smart to trade basely solely on divergences as too many false signals are given. It’s not 100% foolproof, but when used as a setup condition and combined with additional confirmation tools, your trades have a high probability of winning with relatively low risk.

Divergences on longer time frames are more accurate. You get less false signals. You will also get less trades but your profit potential is huge. Divergences on shorter time frames will occur more frequently but are less reliable. I personally only look for divergences on 1-hour charts or longer. Other traders use 15-minute charts or even faster. On those time frames, there's just too much noise for my taste so I just stay away.