Divergence Trading Strategy

Divergence Trading Strategy

Every single day trader has losses when they’re starting out. I can tell you with certainty that 99% of my losses when I was starting was because I could not spot the divergence. So, in this video I’m gonna show you exactly how to enter every single one of your trades based on a divergence that’s going to give you a very high probability of success.

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RSI divergence trading strategy

This is the moving average show where we discuss everything day trading to keep you profitable on a consistent basis. If you have watched my previous videos, I’ve lost lots of money in the Forex markets when I was first starting out. I didn’t let those losses keep me from continuing my education and getting better and better day in and day out. Now I trade profitably on a consistent basis and 99.999 percent of my success is due to spotting a divergence whether it’s a bullish or bearish regular divergence or a bullish or bearish hidden divergence.

Click on the indicators tab and type in RSI. It is in the built-ins it is the relative strength index. Put a star next to it you want on every single one of your charts and click it once. Once it’s up on your chart you’re gonna see the indicator down here on the bottom it’s gonna look different than mine. But, here’s how you can adjust your settings: click the settings wheel right here, leave the length at 14 and change the style. I like yellow because that’s the color theme of the channel. So, you can change your RSI color to yellow and you’re going to change the upper band and lower band to 50 and 50 making it a solid line not a dotted line then your RSI will look exactly like mine. The reason we’re doing it this way is because looking at the market as overbought or oversold is the wrong way to trade the RSI . The RSI is a momentum indicator. It is showing momentum in a specific direction likewise it also shows a loss of momentum in a certain direction.

Best pairs for divergence trading

That’s where the divergences come into effect. So, the first divergence example I want to show you is a regular bullish divergence, you can see that the price was coming down for quite a period of time every single time creating a new lower low all the way down to here. As these lows continue to form my eye is always going to the rsi to spot a big fat divergence, this is how to catch a solid trend reversal. So, as you can see here the price created a lower low. But, on the RSI level of this bottom was 19 and for this bottom it was 21 meaning that the downwards momentum that the price action is showing is no longer valid because it’s got a loss of momentum. It’s higher up on the relative strength index. At this point it started to reject and come up now. What I want you to do for entries is watch a solid rejection. This candle is too small for a rejection. So, you want to wait for a subsequent candle in that direction at that point.

Divergence Trading Strategy photo

You can put in your order with a stop loss below the wick of this candle at the bottom here. Now what I want you to do when you’re first starting out is set your risk to reward ratio. For a one to two meaning that your risk is one and your reward is two once this target hits. I want you to close ninety percent of your trade, move your stop loss for the remaining ten percent into profit. So, it’s a completely 100 risk-free trade and let that thing ride until you’re comfortable with your profits. Don’t be greedy, take your profits when you can if you’re new just take 100 of the trade right here at a one to two. So, that’s how to spot a trend reversal with a divergence on the way up. Now this is an example of a regular bearish divergence, you can see the price was climbing up creating higher highs consistently. Then at this higher high we had a rejection two rejection candles off of this high.

Divergence trading strategy no indicators

Divergence Trading Strategy picture

So, again my eye goes to the RSI and we see a lower high on the RSI. This is another divergence, but this divergence means it’s going to go down again putting in your short position here at the close of the second candle with your stop loss above the previous high targeting a one to two risk to reward ratio. Again once you get out of being a beginner day trader you can continue to hold these trades depending on the strength of the movement, what I mean by that is seeing these big fat red candles shows a lot of momentum in that direction. But, again I want you to close 90 of your trade at your normal profit level and then let the rest ride. So, just to clarify we had a higher high in the price action. But, a lower high in the RSI. Now there are two other types of divergences. These are the ones if you are new I want you to only use these they are hidden divergences. Now the reason I say if you are new is because the number one rule in day trading and any forex trading. Trading cryptocurrencies is the trend if your friend always trades with the trend. This is going to give you the highest probability of success. The issue is how do you know if a trend is going to continue or reverse? That’s when the hidden divergences come into play.

Divergence Trading Strategy image

So, instead of waiting for a reversal we are actually going to trade with the trend looking for these hidden divergences. This is an example of a hidden bullish divergence. You can see that the price was making higher lows. But, on the RSI it was making a lower low. Now let me explain how this works. The momentum was going up correctly as it went up and started to come down. It became more oversold at this point than it was at this point meaning that we are in an uptrend. But, at this point it is more oversold so if something is oversold. It should continue up. So, we get this big fat rejection candle and these are the ones that are the strongest instead of waiting for two you can trade just off of this one. Go in for your long position targeting the bottom of that big move candle and going for a one to two risk to reward ratio. Now the other hidden divergence is on the downside.

Divergence trading system

Divergence Trading Strategy graphics

It is a hidden bearish divergence the price is going down creating these lower highs yet. At this point on the RSI it was much higher meaning that the market at that point was more overbought than it was at the previous high when something is overbought that means some selling should occur. So, that is your signal for the trend continuation down. Again we got this big fat rejection candle and you could have traded off of that on your short position targeting the top of that candle as your stop loss going for a one to two risk to reward ratio. Now how much could you have made off of every single one of these trades that I just showed you on this is euro australian dollar and with this one move you got 36 pips on australian dollar US dollar which is the hidden bullish divergence. You would have gotten 41 pips on this one move now the regular divergences that I showed you were both on indices one was on us 30 and one was on the german 30. This one move right here this one to two risk to reward ratio got you a hundred point move on an index using a 0.01 lot size on this move. This is a hundred dollars profit with a 50 risk on us 30. We had that regular bullish divergence this is a 321 point move with a 158 point stop loss so again on a 0.01 depending on your contract size. This could have profited you 321 dollars and that was just in a few hours now all this analysis was done on the one hour time frame. I suggest you do this on a higher time frame because these divergences hold more weight than they would on the five minute or the one minute. The concept still works the same on every single time frame you just need to be more aware of the fact that there are more false signals on lower time frames. Now when it comes to false signals, this is how you can actually prevent yourself from getting in on a false signal and waiting for more confirmation and more confluence using a trend line on these trend reversal trades.

How accurate is divergence trading

Divergence Trading Strategy today

So, it’s only for the regular bullish divergence or the regular bearish divergence trades. I’m going to get rid of my order position right here. What we’re going to do is actually draw a trend line. I have a trend line drawn here to show you the lower low and the higher low on the RSI. But, what we’re gonna do is draw a trend line on this price action as the price is continuing down. It is maintaining a trend, so you draw a trend line across the tops of the highs. Once the price actually breaks through that trend line and you’re getting the divergence here on the RSI. At this point we’ve broken the trend and the trend is reversing because we can see that in the RSI with the divergence.

So, at this point when you can get into your long position, always wait for the close of the candle because the close of the candle is more concrete than waiting until it’s almost closed because it could wick back down being a false breakout of the trend again. Let me show you this on the german 30 drawing a trend line across the bottoms of the price action. You can see that once we broke out of that trend we came up to retest rejected down and formed a new trend causing a trend reversal and that would have been your entry point.

This article is a transcription of a video made by The moving average

Original video: https://youtu.be/VwVEVu0-JWQ