How to use divergence signal in a trading strategy

Choosing a trading system is quite a long process, through which every trader has to go at some point. The difficulty is in finding signals, as well as following them. If you create your own system, trading process will become much is easier as no one knows their product better than the author.

Trading strategies may be based on several signal from different indicators or patterns on the FIX API Forex market. The combination and complementarity of these signals shape the trading system. Most traders use different methods to forecast the entry points, one of which is the divergence signal, which we’ll look at in more detail here.

Divergence is the difference between currency pair quotations and the value of a technical indicator. There are two types of divergence: bearish and bullish, which indicate a downward correction wave and an upward wave, respectively. In fact, divergence indicates a reversal of the price relative to the established movement. This signal will be of use for everyone who uses the trend and counter-trend based trading strategies.

As we have already determined, divergence appears when the price shows an inverse correlation with the indicator. But which indicator exactly? In fact, a set of several simple indicators in FIX API MT4 is perfect to determine divergence: the Awesome Oscillator, MACD, Stochastic, and RSI.

So, let’s take a look at an example of how to combine this signal with a simple trading strategy. For example, consider Bill Williams’ system, as his trading algorithm includes Awesome Oscillator indicator, on the basis of which we will define divergence.

Quotations of the EUR/GBP currency pair are in an uptrend. Williams trading system confirms this movement with ascending lines of the Alligator technical indicator and fractal zone. We see that each new “high” on the chart is above the previous one, which is also a sign of uptrend. Now you want to compare, if there is a difference at these points with the Awesome Oscillator technical indicator. As you can see, every “high” in the quote window coincides with the AO descending value. That is, there is a situation where price increases, while AO falls. This is the situation of discrepancy, or divergence. Also, according to Williams’ system, the quotes strayed from the Alligator lines to form the “first wiseman” signal for sale by this strategy. Thus a FIX API trader gets two signals for sale.

As you can see, this movement is against the trend. Loss limitation will be set above the second “high”, and the take profit can be set in a range between 61.8% and 76.4% of Fibo grid. Thus, the ratio of SL and TP will be 1 to 4, which is an excellent result and increases the mathematical expectation of the trading strategy.

The benefits of introducing divergence signal in the trading system:

  1. An additional signal to search for correction zones that can be supported by other technical signals;
  2. Increase of the number of filters to open a deal at a FIX API Forex broker;
  3. Better risk management (divergence-based trading will always have a short Stop Loss level and a long Take Profit);
  4. A wide range of indicators to find divergence signal;
  5. Ability to work both in the trend direction and against it.

Let’s take a look at a practical example of how to apply signal divergence to a trading system. I am quite sure that this signal is easy to fit in any trading strategy and will be an additional tool for effective analysis and forecasting the future price movement. Moreover, this signal is easy to use and can be automated using a trading algorithm.

 

 

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