In my last post I talked about divergencias macd forex strategy strategy for trading divergence events between different markets. In this post I’ll look at the more commonly used method called oscillator divergence. This is a technical strategy and to use it you’ll just need an oscillator such as MACD, stochastic or RSI. Divergence highlights places where momentum is slowing and is likely to reverse.
The basic idea is to look for inconsistency between the price and an oscillator. Clearly price is reacting in real time. The oscillator however is based on price momentum and is working from recent history. In the strategy described here I always take cue from the oscillator so this dictates the direction of the trade. To experiment with this strategy yourself, you can freely download my indicator and try it out.
These two cases are shown in Figure 1 below. I don’t apply any other classifications. With this method I always follow the oscillator. That is, buys take place when the oscillator is oversold and sells occur when it is in the overbought region. I also always match tops with bottoms. That is, if your trend line on the price chart connects low points, then your trend line in the oscillator chart should also connect lows.
If your line on the price chart connects highs, then your oscillator line should also connect highs. Regular and Hidden Divergence: Is there a difference? Some teaching websites talk a lot about regular and hidden divergence. Hidden divergence is basically an extra classification based on which direction the connecting lines are moving. Personally I think this complicates the trading rules and I don’t use it.
In the end don’t get hung up on classifications. Use what works for you and the market you are trading. Detecting Divergence Events: In Detail Let’s look in detail at how to detect these types of events. All oscillators have a range of values. When the oscillator is at one of these extremes it’s said to be either overbought or oversold. So the first step in the detection process is to look at cases where the oscillator is firmly in overbought or oversold territory.