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Divergence Trading Setups

Divergence is one of the trade setups used by Forex traders. It involves looking at a chart and one more indicator. For our example we shall use the MACD indicator.

 

To spot this trading setup find two chart points at which price makes a new swing high or a new swing low but the MACD indicator does not, indicating a divergence between price and momentum.

 

To look for divergence we look for two chart points, two highs that form an M-shape on the Forex chart or two lows that form a W-Shape on the Forex chart. Then look for the same M-shape or W-Shape on the Forex indicator you use to trade.

 

Example of a Forex Divergence Trade Setup:

In the EURUSD chart below we identify two chart points, point A and point B (swing highs). These two points form an M-shape on the price chart.

 

Then using MACD indicator we check the highs made by the MACD, these are the highs that are directly below Chart points A and B.

 

We then draw one line on the Forex chart and another line on the MACD indicator.

Forex Divergence Trade Example on MACD Indicator

Drawing Divergence Trading Lines

The chart above shows an example of one of the four types of divergences, the one above is known as hidden bearish divergence, one of the best type to trade. Types of divergences are covered in the next lesson.

 

How to spot divergence

In order to spot Forex diverging signal we look for the following:

  • HH=Higher High- two highs but the last one is higher
  • LH= Lower High- two highs but the last one is lower
  • HL=Higher Low- two lows but the last one is higher
  • LL= Lower Low- two lows but the last one is lower

 

First let us look at the illustrations of these trading terms:

M-shapes dealing with price Highs

Higher High Higher Low Divergence Trading

 

W-Shapes dealing with price lows

Higher Low Loer Low Divergence Trading

 

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Example of M Shapes

Examples of M shapes on a Currency Chart

 

Examples of W Shapes

Examples of W shapes on a Currency Chart

 

Now that you have learned the divergence trading terms that are used to explain trading setup. Let us look at the two types of divergences and how to trade these chart setups.

 

There two types are:

  1. Classic Divergence
  2. Hidden Divergence

These two setups are explained on the following tutorials below

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