Learning how to identify divergences can be a handy advanced trading tool, as it is often used to predict reversals or continuations in price action. Looking at divergences means watching the highs or lows of the currency pair and comparing it to the highs and lows of the oscillator. The kinds of divergences can be grouped into four main ones.
The first kind is the regular bullish divergence. This is formed when price makes lower lows while the oscillator makes higher lows, and is useful in pinpointing reversals. Price makes lower lows when it is in a downtrend but the formation of higher lows in stochastic suggests that a new trend is about to take place.
The second kind is known as the regular bearish divergence. The opposite of the bullish divergence, it is used to signal a reversal in the ongoing uptrend. This takes place when price makes higher highs but the oscillator draws lower highs. This indicates that sellers have gathered enough energy to push the pair out of its current uptrend.
Third is the hidden bullish divergence. This takes place when the currency pair draws higher lows while the oscillator sketches lower lows. It is used in predicting a possible continuation of the current trend. Price has higher lows during and uptrend and a lower dip by the oscillator reflects more buying energy to take the pair higher.
The fourth kind is the hidden bearish divergence. This takes place when price makes lower highs but the oscillator sketches higher highs. This also predicts a continuation since price makes lower highs during a downtrend but the creation of higher highs by stochastic means that sellers have more momentum to push the pair down.
Take note though that there are several conventions when it comes to correctly identifying trading divergences. Some are stricter with their rules for marking highs and lows, as some want the oscillator to reach 80 to be called a high or to dip below 20 to be called a low.
The first kind is the regular bullish divergence. This is formed when price makes lower lows while the oscillator makes higher lows, and is useful in pinpointing reversals. Price makes lower lows when it is in a downtrend but the formation of higher lows in stochastic suggests that a new trend is about to take place.
The second kind is known as the regular bearish divergence. The opposite of the bullish divergence, it is used to signal a reversal in the ongoing uptrend. This takes place when price makes higher highs but the oscillator draws lower highs. This indicates that sellers have gathered enough energy to push the pair out of its current uptrend.
Third is the hidden bullish divergence. This takes place when the currency pair draws higher lows while the oscillator sketches lower lows. It is used in predicting a possible continuation of the current trend. Price has higher lows during and uptrend and a lower dip by the oscillator reflects more buying energy to take the pair higher.
The fourth kind is the hidden bearish divergence. This takes place when price makes lower highs but the oscillator sketches higher highs. This also predicts a continuation since price makes lower highs during a downtrend but the creation of higher highs by stochastic means that sellers have more momentum to push the pair down.
Take note though that there are several conventions when it comes to correctly identifying trading divergences. Some are stricter with their rules for marking highs and lows, as some want the oscillator to reach 80 to be called a high or to dip below 20 to be called a low.
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