Day Trading Chart: How To Use Divergence
When you are basing your trading around a day trading chart and making short term trades for quick profits, it is vital to have the best information. This means backing up your system with cross checks against other indicators. Sometimes these other indicators can point up situations or patterns that show you when a trend might be about to break. One of these patterns is divergence.
Divergence is not in itself something that a trader would base a system around. It is more of a secondary signal that confirms or contradicts the signals that you already have. However, do not underestimate its power on this basis. Combined with a system that give signals of trend reversals or retracements, or the formation of new trends, it can hugely add to the probability of success of each trade.
If it confirms your original signal you can go ahead full steam. If it does not, you can hold back and probably save yourself from a losing trade. I do not need to tell you how this can add to your profits on the bottom line.
Divergence can be identified from the oscillating indicators, the most popular of which are the MACD, Stochastic and RSI. Any of these running on your day trading chart with prices in either candlesticks or bar chart form can be used.
Bearish Divergence
Bearish divergence exists when the price chart is apparently bullish but the oscillator is showing a bearish trend.
In this situation a line across the highest highs of the price chart will be showing an upward trend. However, a line drawn across the highest highs of the oscillating indicator will show a downward trend.
If you are in this market going long, it is probably time to get out. If you have a signal to open a trade to go long, the divergence is signalling you not to do it. If you have a signal to open a trade to go short, on the other hand, the divergence is confirming that and you can go ahead.
Bullish Divergence
Bullish divergence is the other way round. It exists when the price movement on the day trading chart is apparently downward, but the oscillator is showing an upward trend.
Here a line across the lowest lows of the price chart will show bearish (downward) movement, while a line across lowest lows of the oscillator will be moving upward.
The signal is the opposite to the previous one. The divergence is signalling that the bearish trend is coming to an end so you can close short trades and open long trades if that fits with the other signals of your system.
Of course no system is 100% accurate and that applies to using divergence in trading just the same as anything else. Financial trading is risky and you can lose.
However, looking for divergence in addition to your regular system can be a very powerful way to add to the success of your system. Boost your profits by spotting patterns in divergence from the indicators on your day trading chart.
