Would you like to know how to trade divergence like a pro? I often use divergence between the MACD, stochastic, or RSI indicators and price, and it’s proven to be an excellent trade setup or qualifier in my own trading.
Divergence is the key component to much of the success that I’ve had in the Forex market and other markets.
I truly believe that learning a divergence trading strategy that works should be a top priority for any technical trader.
In this article I’m going to show you what divergence is, how the pros use it to gain an edge in the market, and how you can use this information to take your trading to the next level.
What is Divergence?
Divergence in trading charts is when price action differs from the action of various indicators, e.g., the MACD, stochastic oscillator, RSI, etc….
Regular divergence (which is the focus of this article) is a reversal signal, meaning it signals a change in the trend.
Example: Price makes a higher high while the indicator makes a lower high (see the image at the top).
When I’m trading regular bullish divergence, I’m looking for periods where price is making lower lows while the indicator is making higher lows.
This is the strongest form of bullish divergence (see the 1st example in the image below).
Bullish divergence can also be defined as a period where price is making a double bottom while the indicator is making higher lows (2nd example).
As a period where price is making lower lows while the indicator is making a double bottom (3rd example).
The opposite is true when trading bearish divergence.
For regular bearish divergence, I’m looking for periods where price is making higher highs while the indicator is making lower highs.
This is the strongest form of bearish divergence (see the 1st example in the image below).
Bearish divergence can also be defined as a period where price is making a double top while the indicator is making lower highs (2nd example).
As a period where price is making higher highs while the indicator is making a double top (3rd example).
Why It Works
The idea with regular divergence is that divergence between price and the indicator is showing decreased momentum that isn’t reflected in price yet.
Regular divergence is essentially telling you that the trend in price is losing some of its momentum, which could be an early indicator of a reversal.
Note: I’ve also written a guide on how to trade hidden divergence, which is a continuation signal, meaning it signals that the trend is more likely to continue.
I’ve been trading divergence on the MACD for a long time, and in recent years I started to really see the benefit of trading RSI divergence as well.
Combining these two (or more) indicators on your charts and waiting for a confluence of signals can be a very powerful way of spotting momentum changes.
Let’s look at some real examples of what these regular divergence patterns look like on a few different indicators.
How To Trade Divergence Like A Pro
In the charts below, you can see some good examples of how to trade divergence between the MACD, stochastic, and RSI indicators and price.
The key, and what separates the pros from the average losing trader, is how the pros combine their divergence trading strategy with other profitable trading strategies.
You can use many different kinds of supporting trading signals when you trade divergence patterns.
For the purposes of this article, we’ll be combining price action signals with our divergence signals to get high-probability entries.
Note: You can learn any of these candlestick signals in my free Price Action Course.
In all of the examples I included in this article, I’ve marked the bullish divergence in green and the bearish divergence in red.
How to Trade Divergence on the MACD
The first example, MACD divergence, can occur between price and either the MACD line (blue) or the histogram (gray).
In the image below, you can see a few examples of how to trade divergence on the MACD, the first of which is bullish MACD line divergence.
Notice that a bullish harami pattern formed at the lower low in price while the MACD line made a double bottom.
Although the harami pattern is relatively weak on its own, the combination of MACD divergence adds strength to our harami pattern, while the harami pattern provides a laser focused entry trigger for trading our MACD divergence.
Note: For a more in-depth guide on how to trade divergence on the MACD, check out my article, Are You Trading MACD Divergence Correctly?
Also, if you want to trade MACD histogram divergence on the MT4 platform, check out my article, The Best MACD Indicator for MetaTrader 4 (MT4).
The next two examples (above) show bearish MACD histogram divergence.
First, price made a double top while the histogram made lower highs. Then, price made three consecutive higher highs while the histogram made three consecutive lower highs.
In both cases, we were provided with bearish engulfing patterns to help us time our entries.
How to Trade Stochastic Divergence
In the chart below, you can see a couple of examples of how to trade divergence on the stochastic oscillator, and one example of stochastic divergence that we would skip.
Most divergence traders trade stochastic divergence from the slower %D line (gray), although some divergence trading techniques that I’ve traded rely on the faster %K line (red).
Note: The stochastic indicator pictured above is set to 8, 3, 3. Nothing else is changed. I prefer these settings when I’m using this oscillator to trade stochastic divergence.
The first two examples of bearish stochastic divergence were accompanied by bearish engulfing candlestick patterns, which helps us choose a high-probability entry point.
However, the last example never had a viable candlestick pattern form at the second or third high, so we would have skipped it.
How to Trade Divergence on the RSI
The last chart (below) shows a couple of examples of how to trade divergence on the RSI. Learning how to trade RSI divergence can be tricky.
You’ll notice that the RSI line chops up and down quite a bit, so it’s not enough to base your RSI divergence trading on just any RSI highs or lows.
You have to make sure that the highs or lows that you’re basing your RSI divergence off of correspond to distinguishable highs or lows in price.
Note: The same is true when you trade MACD, stochastic, or RSI divergence, but the problem is more pronounced with the RSI.
The first example of divergence in the chart above is bullish RSI divergence which was accompanied by a bullish harami candlestick pattern.
On the right side of the chart, we have an example of bearish RSI divergence which was accompanied by a bearish engulfing candlestick pattern.
Both of our examples of RSI divergence would have worked out for, at least, a 2:1 reward-to-risk ratio.
You may or may not have noticed that all of these divergence examples are from about the same time period. I did this to more easily illustrate the similarities and differences of each indicator.
The stochastic oscillator did not catch that first big bearish divergence that you can see on the other two charts, so I moved it forward a bit to show some other examples.
The point being that each indicator may reveal slightly differently trading opportunities at times.
Some traders like to stack two or more of these indicators on their charts (as I mentioned I do).
When two or more of them are showing divergence at the same time, they can reveal some very high-probability trading entries.
Learning how to trade divergence is powerful, but divergence signals should only be treated as indications of possible trading opportunities – not as buy or sell signals in and of themselves.
The pros always combine other trading signals with divergence to gain an edge in the market.
Learning how to trade price action is a great compliment to any divergence trading strategy, but it’s definitely not the only way of combining entry signals.
In any case, successful trading is the act making better trading decisions than about 95% of other traders, which is easier said than done.
It takes a proven trading system, great psychological discipline, and impeccable money management. Learning a divergence trading strategy for the MACD, stochastic, or RSI might just give you the edge you need over the typical, unprofitable, retail traders.