How to trade effectively using mainly the methods of technical analysis? Every trader having at least small experience of work at Forex undoubtedly asks himself this question. For he finds technical analysis the easiest to access method of making predictions. However, in order to gain expected profit, you should learn how to use it with highest efficiency. Sadly, but most participants of trading sessions at Forex are beginners, who merely search for a good time to open a positions to the trend. Can such strategy help you to gain the desired financial independence? We looked for answers to this and other questions with experts of YA-HI.com company.
Trends and Divergences
Having questioned the traders we know, we were surprised to find out that each of them clearly understands what a trend is, unlike the meaning of the word divergence. Though, there is nothing to be astonished at here. As explained by specialists, these are mere consequences of mass teaching of beginners, which is held by broker companies and other organizations, which do not worry a lot whether a trader will be able to reach high level of theoretical knowledge.
What do they usually want to put into heads of beginning traders? As a rule, he is told that he should trade by the trend, limiting possible losses by stop loss. What happens to a trader, who tries to clearly follow this advice? First of all, a beginner almost never can define the moment of trend formation. As a result, he starts “seeing” it only when it has been written in media and told by tens of analysts. It’s ok if a trend is long-term. If by the moment the trader notices it, it will not have exhausted itself, the trader will have a chance to make money. But, unfortunately, for most of the time currency pairs and other financial instruments do not follow the trend. Moreover, even in the framework of a trend there often happen corrections, which lead to closing positions at set stop loss points and record losses instead of profit. Why does this happen? “Because,” say the experts, “traders do not consider influence of divergence".
Let us remind that Divergence literally means “finding the difference". In exchange trade this is a situation when quotations move in the direction, different to the one shown by most indicators. Divergence often contradicts a trend. Therefore, there can arise a situation when a trader, in his all certainty, effects buying, but an instrument unexpectedly gets much cheaper (or on the contrary). Such participant of the market simply failed to consider the factor of divergence, and, consequently sustained a loss.
At the same time, experts of Forex market claim that a clear understanding of divergences, a skill to define them is the way, which will allow using market volatility with maximal benefit. In particular, divergence enables to notice at an early stage that a trend or its separate wave is losing its strength, and in the nearest time quotations will start reverse movement.
We know that the market moves up or down. At the same time, oscillators show only recent history of quotations change. If they rise, oscillators also point to growth; if drop – to decline. When the market reverses, most indicators will also point to reversal direction. But for a trader this will only be a statement of fact, reflection of what has already happened. Whereas he would like to know beforehand when another minimal or maximal point will be reached, so that he could make good deals.
According to analysts, one of simplest ways to define divergence is connected with oscillators. For example, when the market shows high maximum (deep minimum), oscillator follows it. But the chart clearly shows that it indicates much smaller levels. This is a sign of divergence formation. In other words, we see that the market is getting weaken, potential of sellers (buyers) is close to exhaustion, and this is why we should expect at least a short-term reversal movement of quotations. If you assess the situation incorrectly, it will considerably spoil your trade and bring losses.
Type of Divergence
In forecast made by analysts we often meet phrases "bullish divergence" or "bearish divergence". Let us admit that "bullish" divergence is formed at descending trend and indicates that the market will start rising in the nearest future ("bearish" – on the contrary). There will not necessarily happen market reversal. Most likely, there will be a correction, a pullback, a bounce… However, a trader has to understand that this gives him new opportunities to effect additional profitable deals or exit the market in order to enter it later on more profitable terms.
There distinguish several types of divergence:
1. Classic/Regular.
2. Hidden.
3. Exaggerated.
Classic divergence is met most frequently. It arises directly before a trend reversal. Formation of classic (regular) divergence is a signal to open long-term counter-trend positions. For example, if there arises "bearish" divergence, it means that quotations have been growing until now, and they will probably rise a little more in short-term perspective. However, in further the chart should be expected to turn downwards. Sales effected on time will help to maximally use the potential of a trend that is being formed and get highest profit.
In order to reveal "bearish" divergence, a trader has watch the chart’s maximal points and state of indicator. Regular divergence arises when there is a big difference between them. Behavior at formation of “bullish” divergence is similar: only instead of selling one should buy, and instead of maximal points a trader should watch minimal ones. Most experienced traders have learnt to define classic divergence at-a-glance. Beginners are advised to hold a more detailed analysis of charts, draw trend lines, consider levels of support and resistance, etc.
Hidden divergence is a signal to continuation of a trend after correction or consolidation. According to experts, seeing it is much more difficult than a classic one. In this case hidden "bullish" divergence signal about further continuation of a rising trend ("bearish" – on the contrary). Practice shows that only high-class professionals can define formation of such divergences with high accuracy. Beginners should listen to predictions of experienced experts. If you to not fully trust them, you can use delayed orders. If the chart goes in the needed direction – good, if not – you lose nothing. However, you should not ignore hidden divergences, for they are clear signals for opening long-term positions, which can bring high profit. Besides, noticing a hidden divergence is important because it can arise after regular divergence and indicate that earlier there has happened just a local reversal, but not change of a trend.
In order to reveal hidden divergence, one should carefully follow the chart’s tops. Thus, a hidden "bearish" divergence arises when quotations drop, but indicator continues to draw higher maximums. With hidden "bullish" divergence everything is vice versa.
As stated by experts, hidden divergence can be compared to a sling. One should strain a rubber so that a loaded pellet shoots reverse. A small pullback of exchange rate in counter-trend movement always gives better conditions for entering the market by the trend.
Exaggerated divergence is similar to classic. However, here a chart draws patterns, which look like double bottom or double summit. In such a case the second bottom (summit) is at the same level as the first one, and an indicator draws a considerably lower minimum (higher maximum).
Exaggerated divergence indicates that a currency pair or another financial instrument will not enter consolidation, but continue moving by the trend after some uncertainty.
Therefore, exaggerated "bearish" divergence signals about high likelihood that quotations will continue to drop ("bullish" – on the contrary). Analysts specify that formed tops (or minimums) do not necessary have to be at the same level. The main sign of expanded consolidation is the fact that an indicator does not draw a double summit when following the chart.
How to Use Divergence in Practice?
In the framework of existing trends financial instruments move only for a short time. What is more, trends often take turns with flats, consolidations, there happen lasting corrections, etc. Unlike this, divergences happen almost all the time. For this reason prediction of market situation by divergences is considered the strongest and most effective method of technical analysis.
Nevertheless, the skill of seeing a divergence comes to a trader only with experience. This is the only reason why beginners should approach them cautiously. First of all, traders are advised to make a certain algorithm of actions, which will later help them to effectively use divergences for making predictions:
- do not try to build your strategy on divergences, which you have not yet learnt to see;
- trade taking into account other methods of technical analysis, paying attention to trends, levels of support and resistance, etc.;
- watch the market carefully even when you do not enter it. This will help you to define divergence correctly in future;
- listen to predictions of experienced analysts, consider fundamental factors and influence of important economic news, which can cross out all conclusions of technical analysis;
- constantly rise your educational level by studying theory;
- before applying trade by divergences with real money, try it out on a demo-account.
