How to Trade Energy Classic Bullish Divergence and Bearish Divergence

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

This trading strategy is a low risk method to sell near the top or buy near the bottom, this makes the risk on your trades are very small relative to the potential reward. However, this is one method with very many whipsaws & 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's already profitable, a good way to identify a profit taking level would be the point where you identify this energies setup.

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

1. Classic Bullish divergence
2. Classic Bearish divergence

Trade Classic Bullish Divergence

Classic bullish divergence set-up forms when price is forming lower lows ( LL ), but the oscillator is making higher lows (HL). The example highlighted & described below displays a picture of this energies setup.

Energy Classic Bullish Divergence

This example uses MACD indicator as a Energies Trading divergence indicator.

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

Classic bullish diverging trading signal warns of a possible change in trend from down to up. This is because even though the price went lower the volume of sellers who pushed the price lower was less as illustrated by the MACD technical indicator. This demonstrates underlying weakness of the down ward 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.

Energy Trading Classic Bearish Divergence

This examples also uses MACD indicator

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

Classic bearish diverging signal warns of a possible change in the trend from up to down. This is because even though the price went higher the volume of buyers who pushed the price higher was less as shown by the MACD indicator. This demonstrates underlying weakness of the upwards trend.

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

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

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

Example of MA Crossover Strategy Strategy Method

Once the divergence signal is given, a trader will then wait for the Moving average crossover system to give a trading 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 crossover system to give a downward bearish crossover signal.

By combining the classic divergence trading signals with other indicators this way, a trader will be able to avoid whip-saws 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.