How to Trade Classic Bullish Divergence & Bearish Divergence Setup
In 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 start going in the opposite market direction. For this reason this trading setup is used as a low risk entry method and also as an accurate way of exit out of a trade position.
This trading strategy is a low risk technique to sell near the top or buy near the bottom, this makes the risks on your trades transactions are very small relative to the potential reward. However, this is one technique 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 position. 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 trading setup.
There are two types, based on the direction of the trend:
- Classic Bullish divergence
- Classic Bearish divergence
XAUUSD Classic Bullish Divergence
Classic bullish divergence setup forms when price is forming lower lows ( LL ), but oscillator is making higher lows (HL). The example depicted and demonstrated below highlights a picture of this trading setup.
XAUUSD Classic Bullish Divergence Setup
This example uses MACD as a divergence technical indicator.
From the example above the price made a lower low(LL) but trading indicator made a higher low(HL), this highlights there's a divergence between the price & the indicator. The signal warns of a possible trend reversal.
Classic bullish diverging signal warns of a possible reversal in the trend from downwards to upward. This is because though the price headed lower the volume of the sellers that moved price lower was less as depicted by the MACD technical indicator. This signifies underlying weakness of the down ward trend.
Classic bearish Divergence Trading Setup
Classic bearish divergence setup occurs when price is showing a higher high ( HH ), but the oscillator is lower high (LH). The screen shot below shows an example of the setup.
XAUUSD Classic Bearish Divergence
This example also uses MACD indicator
From the example above the price made a higher high(HH) but the technical indicator made a Lower High(LH), this highlights there's a divergence between the price & the indicator. The signal warns of a possible trend reversal.
Classic bearish diverging signal warns of a possible change in the trend from upwards to downward. This is because though the price headed higher the volume of the buyers that moved price higher was less as depicted by the MACD indicator. This indicates the under-lying weakness of the upward trend.
In the example above, if you had used divergence trading 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 trading 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, MAs & Stochastic Oscillator Indicator.
A good indicator to combine classic diverging setups is the stochastic oscillator and wait for the stochastic lines to move in direction of the divergence setup so that to confirm the signal.
Another good technical indicator to combine with is the moving average MA trading indicator, in this trading indicator a xauusd trader should use the Moving Average Cross Over System
Examples of Moving Average Crossover Technique Strategy
Once the divergence trading signal is given, a gold trader will then wait for the Moving average cross-over 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 upwards cross over signal, while for a bearish classic divergence signal the trader should wait for the Moving average crossover system to give a downward bearish cross-over signal.
By combining the classic divergence trading 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 heading towards this direction, hence the trader will not fall into the trap of picking market tops & bottoms.
Learn More Lessons and Courses:
- How to Trade XAUUSD
- How Can I Trade Fibo Extension Settings in MT4 Software?
- XAUUSD Platform MetaTrader 4 XAU USD Platform Software Connection Bars on Status Bar
- What's a Gold Stop Loss
- Head & Shoulders & Reverse Head & Shoulders XAUUSD Patterns
- XAU USD MAs
- Introduction to MetaTrader 4 XAU USD Dashboard
