Hidden Bullish and Hidden Bearish Divergence Trading
Hidden divergence is used as a possible sign for a trend continuation after the price has retraced. It is a signal that the original Forex trend is resuming. This is the best setup to trade because it is in the same direction as that of the continuing market trend.
Hidden Bullish Divergence
This 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 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 diverging signal between the price and indicator. This signal shows that soon the market uptrend is going to resume. In other words it shows this was just a retracement in an uptrend.
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.
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 Method
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
In this strategy, once the 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 diverging setup wait for the moving average crossover system to give a downward bearish crossover signal.
By combining this signal with other indicators this way one will avoid whipsaws when it comes to trading 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.
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.
For this example there were three take profit levels:
Expansion Level 61.8% - 131 pips profit
Expansion Level 100.0% - 212 pips profit
Expansion Level 161.8% - 337 pips profit
From this strategy combined with Fibonacci would have provided a good strategy with a good amount of profit set using these take profit levels.