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Significance of Divergence

by Leroy Rushing

Profitable traders know the significance of divergence; its significance is usually noted by the large movements that come after a true divergence in price and leading indicator. The most talked about is the RSI divergence, but there are many forms, such as MACD divergence, price volume divergence, and practically any kind of divergence between price and indicators.

Professional traders use divergence

Divergence is only profitable if it can be confirmed, and unfortunately, this is one part of the markets that it's very hard to get a confirmation for. When prices move against an indicator, it could only be short term and change as the market changes. In a downtrend, RSI divergence could mean a breakout is near and an uptrend will begin, but as the market moves on, it would be easy for the indicators to realign, thus costing you time, money and a missed opportunity.

If you could call divergence every time, you would master day trading. While divergence is hard to confirm and should only be used with other indicators, it can be extremely rewarding. Divergence is very profitable because the price has to correct to end the divergence, and then it usually carries on the new path for a much larger movement. This creates a compounded profit potential where there are two booms to every move.

Divergence is usually pretty rare

Divergence doesn't happen very often, especially on chart frames over a few minutes. Even on a 30 minute chart, a good RSI divergence may only happen once every few days. And that is only on the most active of investments. The chance of divergence happening is best at the end of uptrends and downtrends, and they rarely ever occur in a sideways trend. It's best to find a peak or trough and look for divergence, indicating to get in the market. Don't take trades just to trade; you must preserve trading capital while looking for good investments.

Creative techniques to profit from divergence are everywhere. Even professional traders are working hard to secure a way to trade divergence with overwhelming accuracy. The best strategies only take positions at the tops and bottoms of charts and follow candlesticks for buy and sell signals. Each time you limit an indicator and work a strategy around it, you limit the amount of trades you'll be able to take, but hopefully with better accuracy.

Let the market make the divergence

Trading discipline is very important with divergence. It's easy to get sucked into trades before the full divergence shows through. You should always let the trade develop before taking a position, but often it can be difficult to know whether the charts are truly diverging or if it is just a short term difference.

About the Author

Learn how to master day trading by downloading two of Trading EveryDay's FREE products: Tools of the Trade eBook and a Trading Plan Planner. Dedicated to helping people become profitable traders, Leroy Rushing, a professional day trader, trading coach, and author, is the CEO of Trading Ever.

Disclaimer: Foreign Currency trading and trading on margin carries a high level of risk and can result in loss of part or all of your investment. Due to the level of risk and market volatility, Foreign Currency trading may not be suitable for all investors and you should not invest money you cannot afford to lose. Before deciding to invest in the foreign currency exchange market you should carefully consider your investment objectives, level of experience, and risk appetite. You should be aware of all the risks associated with foreign currency exchange trading. All opinions expressed are for informational and analysis purposes only and do not constitute investment advice.