A Method for Trading Divergences - MT4/MT5 Resources
I would like to share with you a method I have recently developed that allows people to harness the powerful nature of divergence. If you are new to this concept, I highly recommend www.babypips.com to enhance your knowledge.
It's a method, not a system. The reason is that there is discretion in some key areas, but the method has parameters that allow traders to stay within their boundaries. This is a method designed to get your winners running and shorten your losses.
Where is the discretion?
First, spotting disagreements takes practice. It takes a lot of effort at first to learn to spot them, but once you're able to do that, they become easy to find. Divergence means you are using an oscillator that shows overbought and oversold conditions. Which oscillator you choose to use is up to you. In all my charts you will see my preferred oscillator combinations...
OsMA(12,26,9) is my primary indicator and Stochastic(5,3,3) is my secondary indicator. I put them in the same window so I can see the two stacked up. You may have another favorite, such as MACD or RSI. Whatever you use works, it will be your preference. You may notice that I have selected two completely different period settings in the oscillator, which gives a slightly different look at the same price information.
For this approach, if divergence occurs on the weekly chart, I will use the daily chart to find entry triggers. If it happened on Daily, I would enter it using 4H. If it happens in 4H, I will use 15M to enter. This is the shortest time frame I have taken this approach. (This is the second area of discretion. If playing 4H, you may prefer a different entry time frame. You may want to use the 1H or 30M charts for entries. As you will see, this is a matter of sensitivity and risk/reward modification...)
Now, let's say you see a good divergence starting to appear, and it appears on the daily chart. At this point, I will turn to the moving average to give me a trigger point. I keep the 3 MA on the screen. You will find that they are lying numbers. (Again, caution... you may prefer a different MA than the one I use, but the concept is the same...)
13 European Index
21 European Index
55EMA
So what I do is drop the daily divergence down to the 4 hour chart and wait for the trigger. For this example, the price is rising and I expect the price to correct downwards. What I would wait for is a close below the 13 EMA (or 21 or 55...again discretion, risk/reward...). Which EMA you choose is up to you, but the key is to be patient and wait for a close below at least the 13EMA. If you use 21 or 55, you will be more likely to win the trade, but you will leave some points on the table.
Next, we turn to Fibonacci retracements as our stops and targets. This will become apparent on my chart, but I use the beginning of the move that initiates the divergence pattern to plot Fibonacci. The key to this system is the observation that once a divergence occurs and a correction occurs, you will most likely see price hit the 23.6% line. Many times it hits the 38% line and sometimes it hits the 50% line.
Once you enter the trade, your stop loss is above the 0% line and you have 3 units on the trading table. Take profit 1 is located at line 23.6. Once you hit this, move the other two units to B/E +10 (or whatever else works for you, but don't lose anything at this point). You then let the trade continue until you are stopped out (still profitable) or you hit TP2 at the 38% line. If price action (see james16) indicates a reversal, you can choose to close the other two units manually, or you can tighten your stop loss slightly to lock in more profits. You may also decide to close your position if the price closes back above the 55EMA. It doesn't matter what you do at this point as long as you enter main protection mode after reaching the first TP level. You probably don't want to use a third unit, but if you do, then the 50% line is certainly your ultimate goal.
If your trade is stopped out, you may see another wave of divergence occur, reinforcing the pattern, or the entire pattern may be broken. What is important is that you exit the market with your money safe, you can reanalyze and wait to see how much the price will rise and if the oscillators still divergence. If you feel that the divergence is continuing and strengthening, then simply repeat the process above, drop down to your entry time frame and wait for a close below the triggering moving average, redraw your Fibonacci with the new high and set a new target.
I will now post some diagrams to clarify these concepts...
It's a method, not a system. The reason is that there is discretion in some key areas, but the method has parameters that allow traders to stay within their boundaries. This is a method designed to get your winners running and shorten your losses.
Where is the discretion?
First, spotting disagreements takes practice. It takes a lot of effort at first to learn to spot them, but once you're able to do that, they become easy to find. Divergence means you are using an oscillator that shows overbought and oversold conditions. Which oscillator you choose to use is up to you. In all my charts you will see my preferred oscillator combinations...
OsMA(12,26,9) is my primary indicator and Stochastic(5,3,3) is my secondary indicator. I put them in the same window so I can see the two stacked up. You may have another favorite, such as MACD or RSI. Whatever you use works, it will be your preference. You may notice that I have selected two completely different period settings in the oscillator, which gives a slightly different look at the same price information.
For this approach, if divergence occurs on the weekly chart, I will use the daily chart to find entry triggers. If it happened on Daily, I would enter it using 4H. If it happens in 4H, I will use 15M to enter. This is the shortest time frame I have taken this approach. (This is the second area of discretion. If playing 4H, you may prefer a different entry time frame. You may want to use the 1H or 30M charts for entries. As you will see, this is a matter of sensitivity and risk/reward modification...)
Now, let's say you see a good divergence starting to appear, and it appears on the daily chart. At this point, I will turn to the moving average to give me a trigger point. I keep the 3 MA on the screen. You will find that they are lying numbers. (Again, caution... you may prefer a different MA than the one I use, but the concept is the same...)
13 European Index
21 European Index
55EMA
So what I do is drop the daily divergence down to the 4 hour chart and wait for the trigger. For this example, the price is rising and I expect the price to correct downwards. What I would wait for is a close below the 13 EMA (or 21 or 55...again discretion, risk/reward...). Which EMA you choose is up to you, but the key is to be patient and wait for a close below at least the 13EMA. If you use 21 or 55, you will be more likely to win the trade, but you will leave some points on the table.
Next, we turn to Fibonacci retracements as our stops and targets. This will become apparent on my chart, but I use the beginning of the move that initiates the divergence pattern to plot Fibonacci. The key to this system is the observation that once a divergence occurs and a correction occurs, you will most likely see price hit the 23.6% line. Many times it hits the 38% line and sometimes it hits the 50% line.
Once you enter the trade, your stop loss is above the 0% line and you have 3 units on the trading table. Take profit 1 is located at line 23.6. Once you hit this, move the other two units to B/E +10 (or whatever else works for you, but don't lose anything at this point). You then let the trade continue until you are stopped out (still profitable) or you hit TP2 at the 38% line. If price action (see james16) indicates a reversal, you can choose to close the other two units manually, or you can tighten your stop loss slightly to lock in more profits. You may also decide to close your position if the price closes back above the 55EMA. It doesn't matter what you do at this point as long as you enter main protection mode after reaching the first TP level. You probably don't want to use a third unit, but if you do, then the 50% line is certainly your ultimate goal.
If your trade is stopped out, you may see another wave of divergence occur, reinforcing the pattern, or the entire pattern may be broken. What is important is that you exit the market with your money safe, you can reanalyze and wait to see how much the price will rise and if the oscillators still divergence. If you feel that the divergence is continuing and strengthening, then simply repeat the process above, drop down to your entry time frame and wait for a close below the triggering moving average, redraw your Fibonacci with the new high and set a new target.
I will now post some diagrams to clarify these concepts...
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