Divergence Trading System - Bullish and Bearish Divergence Forex Trading
Hidden divergence trading system is used as a possible sign for a forex market trend continuation after the price has retraced. It is a signal that the original Forex trend is resuming. This is the best divergence trading setup to trade because it is in the same direction as that of the continuing market trend.
Hidden Bullish Divergence - divergence trading system
This divergence trading setup happens when price is making a higher low (HL), but the oscillator (indicator) is showing a lower low (LL). To remember them easily think of them as W-shapes on Chart patterns. It occurs when there is a retracement in an upward Forex trend.
The example below shows an image of this divergence trading setup, from the screenshot the price made a higher low (HL) but the indicator made a lower low (LL), this shows that there was a divergence signal between the currency price and indicator. This signal shows that soon the forex market uptrend is going to resume. In other words it shows this was just a retracement in an uptrend.
divergence trading system
This confirms that a retracement move is complete and indicates underlying strength of an uptrend.
Hidden Bearish Divergence
This setup happens when price is making a lower high (LH), but the oscillator is showing a higher high (HH). To remember them easily think of them as M-shapes on Chart patterns. It occurs when there is a retracement in a downward Forex trend.
The example below shows an image of this setup, from the screenshot the price made a lower high (LH) but the indicator made a higher high (HH), this shows that there was a divergence between the price and the indicator. This shows that soon the market downtrend is going to resume. In other words it shows this was just a retracement in a downward trend.
divergence trading system
This confirms that a retracement move is complete and indicates underlying strength of a downtrend.
Other popular indicators used are CCI indicator (Commodity Channel Index), Stochastic Oscillator, RSI and MACD. MACD and RSI are the best indicators.
NB: Hidden divergence is the best type to trade because it gives a signal that is in the same direction with the current market trend, thus it has a high reward to risk ratio. It provides for the best possible entry.
However, a trader should combine this setup with another indicator like the stochastic oscillator or moving average and buy when the currency is oversold, and sell when the currency is overbought.
Combining Hidden Divergence with Moving Average Crossover Strategy
A good indicator to combine these setups is the moving average indicator using the moving average crossover method. This will create a good trading strategy.
Moving Average Crossover Method - divergence trading system
In this divergence trading system, once the trading signal is given, a trader will then wait for the moving average crossover method to give a buy/sell signal in the same direction, if there is a bullish divergence setup between the price and indicator, wait for the moving average crossover system to give an upward crossover signal, while for a bearish divergence setup wait for the moving average crossover system to give a downward bearish crossover signal.
By combining this divergence trading system with other indicators this way one will avoid whipsaws when it comes to trading with this signal.
Combining with Fibonacci Retracement Levels
For this example we shall use an upward market trend. The currency pair is GBPUSD. We shall use the MACD indicator.
Because the hidden divergence is just a retracement in an upward trend we can combine this signal with the most popular retracement tool that is the Fibonacci retracement levels. The example below shows that when this setup appeared on the chart, the price had just hit the 38.2% level. When price tested this level, this would have been a good level to place a buy order on the GBPUSD currency.
divergence trading system setup
Combining with Fibonacci Expansion Levels
In the example above once the buy trade was placed, a currency trader would then need to calculate where to take profit for this trade. To do this one would need to use the Fibonacci Expansion Levels.
The Fibonacci expansion was drawn as shown on the chart as shown below.
divergence trading system setup
For this example there were three take profit levels:
Fibonacci Expansion Level 61.8% - 131 pips profit
Fibonacci Expansion Level 100.0% - 212 pips profit
Fibonacci Expansion Level 161.8% - 337 pips profit
From this divergence trading system combined with Fibonacci would have provided a good trading strategy with a good amount of profit set using these take profit levels.
