Divergences

Divergences. All beginners, as well as more or less confirmed, know these strategies. Indeed, when an indicator is lowering again while prices are rising, or vice versa, we say that there is a divergence between the price and the indicator.

This is something that every beginner will be eager to trade with enthusiasm… Error.

Indeed, although a divergence will alert us to a probable price slowdown, this should only be considered like any other indicator. Trading without having more information than a simple divergence will certainly lead the trader to a loss.

These divergences are interesting to trade but must be used in conjunction with other indicators. Several factors must converge in the same direction for a trade to be possible: the more indicators converge in one direction, the greater the probability that the trade will succeed. The convergence factor of “market signs” is essential.

 

–> Example

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A beautiful bearish divergence like everyone loves them. However, did we have to trade this in a vacuum?

 

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This time, many factors ”converge” in the direction of a decrease. Indeed, prices are at the top of the volatility 50 periods (in grey), are under resistance (in yellow), on a retracement of 61.8% of the previous decline and even break the oblique that had been used as support for 25 days! The divergence of the RSI is only an additional convergence factor that indicated a potential slowdown, then a downward price reversal and therefore an opportunity for short with a STOP above the -potential- resistance.

 

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Prices will then drop by about 30%, giving the swing trader a nice ratio of 3 and the trade will have to be closed on the support. Note that as the latter approaches, prices move slightly out of the Bollinger Bands in 50 periods, which, once again, is a converging factor, this time in the sense of profit taking.

 

What is important to understand is that no single indicator, oscillator, technical framework or setup is a win-win situation. There will always be failures in trading and the only thing that small investors and experienced professional speculator need is regularity. And for that, there is only one thing to understand: statistical advantage. A globally winning operation repeated thousands of times, will result in a significant gain. Even if there will be failures, regularity and therefore the probability of success are the only numbers that should be kept in mind.

 

That is why I recommend noting this famous sentence ”focus your mind on the convergence of indications, factors, and indicators rather than on their divergences”.


Want to learn more? The following articles may be of interest to you

‘Reading a chart”

”Fibonacci retracements” 

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