The price is in constant motion. Its changes are the base for opening trading positions. You will observe the downtrend and the uptrend in the market. But occasionally, it will be hard to catch the price direction. What to do in such circumstances? Search for divergences.
Convergence/divergence and oscillators
To observe convergence and divergence it is necessary to add an oscillator to the price chart. There are multiple types of them, but the main functional rules are the same.
To identify the trend, a trader can use various tools. You can draw a trendline or use a moving average or analyse numerous timeframes.
The convergence shows the strength of the trend. It occurs when the price and the oscillator line are going in the identical direction. During the uptrend, they will both form higher highs and during the downtrend, lower lows. It informs us that the previous price direction will be most probably continued.
The divergence happens when the price and the oscillator are not moving in the same direction. You can observe that the price forms higher highs, but at the same time, the oscillator creates a lower high. Or when the price forms lower lows, the oscillator makes higher lows. The divergences give information that the trend weakens and it will probably soon change the direction.
Some of the oscillators that can be used to spot divergences
Below, you will find an exemplary chart for the USDJPY currency pair and the Stochastic Oscillator attached. Note how the price is rising but the oscillator line is falling. On this basis, you can expect the reversal of the trend.
The next chart shows the divergence observed with the help of the Moving Average Convergence Divergence indicator. It looks a bit different than the Stochastic, but the principals remain the same. The price and the oscillator are not going in the same direction. The price is dropping while the MACD is rising. The trend reversal will happen soon.
The Commodity Channel Index is yet another oscillator that will help you to spot divergences. Below there is an example of bullish divergence with this indicator attached.
Divergences themselves are not giving strong signals. The oscillator may be quite a prolonged time in the divergence before the change in the price occurs. This is why you can use an extra confirmation in the form of price action techniques. Follow the candlesticks patterns and you will get good points of entry for your transactions.
A double bottom pattern is one of the examples. Take a look at the chart below. The pattern confirms bullish divergence on the Relative Strength Index oscillator.
Below, you will find the EURUSD chart where the price moves up and the RSI falls. The Head and shoulders pattern confirms where to open a trading position.
Identifying the trend is an important skill in trading. And catching divergences too. The best way to do this is to add an oscillator and observe its movements in relation to the price.
Divergences may produce weak trading signals thus it is a good idea to use additional techniques such as recognising candlesticks patterns.
Divergences do not happen all the time and you need some practice to be able to spot them. Remember, there is a free demo account on the Binomo platform. Try trading with divergences there.