How to Trade Commodities Classic Bullish Divergence & Bearish Divergence

In commodities trading, classic divergence is used as a possible sign for a commodity trend reversal and is used by commodity traders when looking for an area where price could reverse and start going in the opposite market direction. For this reason this setup is used as a low risk entry method and also as an accurate way of exit out of a trade.

This strategy is a low risk method to sell near the top or buy near the bottom, this makes the risks on your trades are very small relative to the potential reward. However, this is one technique with very many whipsaws and most traders do not recommend using it.

Divergence in Trading is also used to predict the optimum point at which to exit a trade. If you already have an open trade that is already profitable, a good way to identify a profit taking level would be the point where you identify this setup.

There are 2 types, based on the direction of the trend:

1. Classic Bullish divergence
2. Classic Bearish divergence

Commodity Classic Bullish Divergence

Classic bullish divergence set-up forms when price is forming lower lows ( LL ), but oscillator is making higher lows (HL). The example illustrated and demonstrated below portrays a picture of this setup.

Commodities Classic Bullish Divergence

This examples uses MACD indicator as a Commodity divergence indicator.

From the example above the price made a lower low(LL) but indicator made a higher low(HL), this portrays there is a divergence between the price and indicator. The signal warns of a possible trend reversal.

Classic bullish diverging signal warns of a possible change in trend from downward to upward. This is because even though the price headed lower the volume of the sellers that pushed the price lower was less as illustrated by the MACD technical indicator. This indicates underlying weakness of the downwards trend.

Classic bearish Trade Divergence Setup

Classic bearish divergence setup occurs when price is showing a higher high ( HH ), but the oscillator is lower high (LH). The image below shows an example of the setup.

Commodity Classic Bearish Divergence

This examples also uses MACD indicator

From the example above the price made a higher high(HH) but the indicator made a Lower High(LH), this portrays there is a divergence between the price and indicator. The signal warns of a possible trend reversal.

Classic bearish diverging signal warns of a possible change in the trend from upward to downward. This is because even though the price headed higher the volume of the buyers that pushed the price higher was less as illustrated by the MACD indicator. This indicates underlying weakness of the upward trend.

In the example above, if as a trader you had used divergence trade setup to trade you would have gotten good trading signals to enter or exit the trades at an optimal point. However, divergence signals just like other indicators, is also prone to whip-saws. That's why it is always good to confirm the diverging signals with other technical indicators such as the RSI, Moving Averages & Stochastic Oscillator.

A good indicator to combine classic diverging setups is the stochastic oscillator & wait for the stochastic lines to move in direction of the divergence signal so as to confirm the signal.

Another good technical indicator to combine with is the moving average indicator, in this technical indicator a trader should use the MA Cross-over System

Example of Moving Average Crossover Technique Method

Once the divergence signal is given, a trader will then wait for the Moving average crossover system to give a signal in the same direction, if there is a classic bullish setup, a trader will wait for the moving average system to give an upward crossover signal, while for a bearish classic divergence signal the trader should wait for the Moving average cross over system to give a downward bearish crossover signal.

By combining the classic divergence signals with other indicators this way, a trader will be able to avoid whipsaws when it comes to trading the classic diverging signals, because the trader will wait until the market has actually reversed and is already moving towards this direction, hence the trader will not fall into the trap of picking market tops and bottoms.