Technical traders are using numerous indicators to receive different market signals and make well-educated and logical trading decisions.
There are instances when indicator value moves in a certain direction and the price is moving towards the opposite direction. This is called Divergence, and it can be used by traders as an indicator that the market is shifting. Divergence indicator for FX traders signals that the current trend is weakening, and it’s expected the price to reverse direction.
What is the FX Divergence indicator
Divergence is when the price of an asset is moving in a different direction compared to the signal provided by an indicator we are using. This can be considered as an indicator itself, and it indicates to us that there might be an upcoming price reversal, and the asset might change its trend direction. Divergence can be both positive and negative, and it depends on the direction of price movement compared to the direction of the indicator to determine which Divergence we have. If we see that price of an asset makes new lows while the indicator makes new highs, it means that we have a positive Divergence. And there is a high likelihood that prices will start to go up soon. While if we see the price reach new highs, but the indicator is showing new lows, it means that we have a negative Divergence, and the price might start to fall soon. This is why some consider Divergence as an indicator, while technically it is not.
You can use various indicators to trade divergence in Forex. Some of the most popular indicators that you can use are: the relative strength index (RSI), stochastic oscillator, Awesome Oscillator (AO), and moving average convergence divergence (MACD).
One thing that traders should not mistake is that Divergence is not a confirmation. Confirmation is when different indicators and prices are signaling and telling the trader the same things. This is called confirmation, as everything is pointing towards the same thing. While Divergence, being the clash of two opposites, means that this is not a confirmation but a simple signal that prices might change a direction.
How to trade with Divergence
When it comes to trading with the Forex Divergence indicator, there are multiple ways to do so, but the main idea is always the same. As Divergence appears when the price moves opposite direction compared to the signals received from indicators, we need to use indicators that show the momentum of the price as these types of indicators are the best for trading with Divergence. Below, we will go over some indicators and strategies that we can use when trading with the FX Divergence indicator.
Trading Divergence with RSI
Probably the most popular indicator for trading Divergence, the Relative Strength Index, is an oscillator that is placed below the chart and has a range of 0 to 100. RSI looks at average price gains and losses for the past 14 periods and shows when the asset is overbought or oversold. When using this indicator with 14 periods, it shows few signals about overbought and oversold assets, but these signals are highly reliable and traders can have confidence that it shows mostly correct data.
When we are FX trading with Divergence indicator as RSI, we simply need to put this indicator below our chart and watch where the indicator goes. Generally, when RSI goes over 70 it is considered that the asset is overbought, while when it falls below 30, it shows that the asset is oversold. If we see that the RSI indicator is showing new highs, but the price has fallen to a new low, it can be considered as a signal that the price might turn around and start rising soon. While using RSI, we won’t see Divergence that much, but when we see it, we can be confident that this is a relatively accurate reading.
Divergence indicator in trading
For more simplicity, there are custom Divergence indicators built by traders themselves. For example, when using TradingView we can select a few of these Divergence indicators in FX trading. When using this indicator, it simply shows you a new oscillator at the bottom of the chart, and it showcases both bearish and bullish Divergences. This is a great tool to use for newcomers who might have problems spotting the Divergence themselves and can use this indicator to simplify this process. When looking up this indicator, we were not able to find out exactly which indicator was used for making this Divergence indicator, but looking at the charts, we can see that the information provided by it is accurate.
Below is the Divergence indicator example with EUR/USD pair. Looking at this chart, we can see the Divergence indicator plotted below the chart, with indications of when Divergence occurred and what type of Divergence is there. Bull Divergences, which are indicated as green lines, are instances when price reached new low highs, while the indicator showed new high highs. While, Red bearish Divergences are shown when the price showed new high highs, and the indicator showed low lows.
FAQs on Divergence Indicator
Can you make money with Divergence indicator?
Divergence trading can be highly profitable for some technical traders. However, it’s worth mentioning that every trader is different and what works for one trader may not work for you. The best way to know whether divergence trading is for you or not is to test the trading strategy using a demo account.
What are the benefits of using Divergence indicator?
The main benefit of the Divergence indicator is that it gives signals of price changes before these changes even occur. Also, Divergence is not something common, so it has relatively good accuracy, and if we see one we can be confident that reversal is about to happen, but be sure to also confirm it with other trend reversal indicators.
Is Divergence indicator accurate in FX trading?
Yes, the Divergence indicator has relatively high accuracy in FX trading. For example, when using RSI, we will not see Divergence occur that much, but once price and the indicator value diverge, we get a signal that the current trend is weakening and price might reverse.