Divergence Setups - Bearish Divergence Trading and Bullish Divergence Trading

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

To spot this divergence setup find 2 chart points at which price makes a new swing high or a new swing low but the MACD indicator doesn't, indicating a divergence between price and momentum.

To look for divergence setup we look for 2 chart points, 2 highs that form an M-shape on the chart or two lows that form a W-Shape on the chart. Then look for same M-shape or W-Shape on indicator that you use to trade - for examples RSI indicator or MACD indicator.

Example of a Divergence Trade Setup:

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

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

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

Drawing Divergence Lines - Forex Bearish Divergence Trading and Bullish Divergence Trading

The chart above displays example of one of the four types of divergences setups, the divergence set up above is known as hidden bearish divergence, one of the best type of divergence to trade because it gives signals that are in same direction as that of the current trend. Types of divergences setups are covered in the next learn lesson.

How to Identify Divergence Setups

In order to identify divergence signal we look for 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 divergence terms:

M-shapes on charts dealing with price Highs

W-Shapes on charts dealing with price lows

Example of M Shapes on Charts

Examples of W Shapes on Charts

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

There two divergence types which are:

1. Classic Trade Divergence

2. Hidden Divergence

These two divergence setups - classic divergence and hidden divergence are explained on the following learn guides in the next lessons - divergence definition lessons.