Divergence Trading Setups Summary - XAUUSD GOLD TRADING
Classic Bearish Divergence - HH price, LH indicator - Indicates underlying weakness of a trend - Warning of a possible change in the trend from up to down.
Classic Bullish Divergence - LL price, HL indicator - Indicates underlying weakness of a trend - Warning of a possible change in the trend from down to up.
Hidden Bearish Divergence - LH price, HH indicator - Indicates underlying strength of a trend - Mainly found during corrective rallies in a downward trend.
Hidden Bullish Divergence - HL price, LL indicator - Indicates underlying strength of a trend - Occurs mainly during corrective declines in an upward trend.
Illustrations of the divergence terms:
M-shapes dealing with price highs
M-shapes: Divergence Trading Terms
W-shapes dealing with price lows
W-shapes: Divergence Trading Terms
These are the shapes to look for when looking for when using divergence trading setups.
One of the best indicators for using with this divergence trading setup is the MACD Indicator - as a divergence trading signal, MACD divergence is a high probability setup to enter a trade. But as with any signal there are certain parameters that have to be observed to make this trading signal a high probability setup.
Getting straight in to a trade as soon as you see this setup is not the best strategy to use. This divergence trading setup should be used in combination with another technical indicator to confirm the direction of the XAUUSD price trend. A good system to combine this setup with is the moving average crossover method.
Be aware this setup on a smaller time frame is not so significant. When divergence is seen on a 15 minute price chart it may or may not be very important as compared to the 4 hour chart time-frame or the 1 day chart timeframe.
If seen on a 60 minute chart, 4 hour chart, or daily chart time-frame, then start looking for other factors to indicate when the price may react to the divergence.
This brings us to a key point when using this signal to enter a trade: on a higher time frame MACD divergence can be a fairly reliable indicator of a change in price direction. However, the big question is: WHEN? That is why getting straight in to a trade as soon as you see this divergence setup is not always the best strategy.
Many traders get caught out by entering the market too soon when they see MACD divergence setup. In many cases, price has still got some momentum to continue in the current market direction. The trader who has jumped in too soon can only stare at the screen in dismay as price shoots through his stop loss taking him out.
If you simply look for this divergence trading setup without any other considerations you will not be aligning yourself with the best chance, so to increase the chance of making a successful trade you should also look at other factors, specifically other indicators.
What other factors should you consider when using this divergence trading setup?
1. Support, Resistance and Fibonacci levels on higher time-frames
Another way to greatly increase the chances of a winning trade is to observe the higher chart time frames before opening an order based on the lower time frames.
If you observe that the hourly, 4 hour or daily price chart has met a major resistance, support or Fibonacci level then the probability of a successful trade based on divergence signal on a lower time frame at this point increases.
2. Reward to risk ratio
And finally, when looking for divergence trading setups, it is very important that you enter the trade correctly, so that you have a good risk: reward ratio and only open trades that have more profit potential than what you are risking. If you understand how to enter a trade properly, you can measure your risk: reward ratio before you open a trade. That way, you can only choose to open trading orders that offer a favorable risk: reward ratio.
Finally, when used correctly and combined with other technical indicators to confirm this divergence trading signal, divergence trading setup can offer a good trading method for trading XAUUSD Gold metal.