How Do You Trade Classic Bullish Divergence and Bearish Divergence
In XAUUSD trading, classic divergence trade setup is used as a possible signal for a price trend reversal & it is used by XAUUSD traders when looking for an area where the price could reverse and begin going in the opposite trend direction. For this reason this classic divergence trading pattern is used as a low risk entry method and also as an accurate way of exiting out of an open Gold trade.
This classic divergence trading strategy is a low risk method to open sell near the top or buy near the bottom, this makes the risk on your trade positions very small compared to potential reward. However, this is one method with very many whipsaw fakeouts & most traders do not recommend using it.
Classic divergence pattern in XAUUSD trading also is used to predict the ideal optimum level at which to exit an open transaction. If you already have an open position that is already profitable, a good way to identify a profit taking and booking zone would be the point where you spot this divergence trading setup.
There are two types of classic divergence - based on the direction of the Gold price trend:
- Classic Bullish Divergence Trading Setup
- Classic Bearish Divergence
Classic Bullish Divergence Trading Setup
Classic bullish divergence pattern occurs when price is forming/making lower lows (LL), but the technical indicator is forming/making higher lows (HL). The example illustration put on display below shows picture of this classic divergence trade setup.
Classic Bullish Divergence Trade Setup - Gold Trading Chart
The example above uses MACD indicator as a divergence indicator.
From the above example the price made a lower low (LL) but the technical indicator made a higher low (HL), this shows there is a divergence setup between the Gold price & the indicator. The signal warns of a possible price trend reversal.
Classic bullish divergence trading signal warns of a possible change in the XAUUSD price trend from downwards to upwards. This is because even though the market price went lower the volume of the sellers who pushed price lower was less than before when you compare and analyze the two lows - as illustrated and shown by the MACD indicator.
This indicates underlying weakness of the downwards Gold price trend.
Classic Bearish Divergence Trading Setup
Classic bearish divergence trading pattern occurs when price is making a higher high (HH), but the oscillator indicator is making a lower high (LH). The example illustration put on display below illustrates this setup of classic bearish divergence trading setup.
Classic Bearish Divergence Trade Setup - Gold Chart
The above example also uses MACD
From the above illustration the price made a higher high (HH) but the technical indicator made a lower high (LH), this shows there is a divergence setup between the Gold price & the indicator. The signal warns of a possible market trend reversal.
Classic bearish divergence trading signal warns of a possible change in the Gold price trend from upwards to downwards. This is because even though the price went higher the volume of the buyers who pushed price higher was less just as is illustrated by the MACD indicator.
This reflects the under-lying weakness of the upwards Gold price trend.
In the above illustrations, if you had used classic divergence trading set-ups to trade you'd have gotten good trading signals to enter or exit the trade transactions at an optimal point. However, divergence trading signals just like other technical indicators is also prone to fake outs. That is why it's always good to confirm the divergence trading signals with other indicators like the RSI, MAs Moving Averages & Stochastic Oscillator Technical before you open a position.
A good indicator to combine classic divergence trading pattern is the stochastic oscillator and wait out for the stochastic indicator lines to move in the direction of the divergence trading signal so that to confirm the trade signal.
Another good indicator to combine with this setup is the moving average MA indicator, in this indicator a gold trader should use the Moving Average Crossover System to confirm the trade signal derived and generated by the divergence trading setup.
Explanation of Moving Average Cross over Method
Moving Average Crossover Method Combined With Classic Divergence Trading Setup
Once the divergence signal is generated, a trader then will wait for the Moving Average(MA) crossover method to give a trading signal in the same market direction, if there's a classic bullish divergence trading signal, a trader will wait for the moving average crossover method to give an upward crossover signal, while for a bearish classic divergence trading signal the trader should wait out for the Moving Average(MA) crossover system to give a downward bearish crossover signal.
By combining the classic divergence signals with other technical indicators this way, a trader will be able to avoid whipsaws when classic divergence trading signals, because the trader will wait until the market has actually reversed & is already moving towards the generated signal direction - hence the trader won't fall into the trap of picking market tops and market bottoms by entering trades before the actual divergence trading setup pattern has been confirmed.
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