Using divergences to predict price action is an advanced trading technique, but the bottom line is that these are used to identify continuations or reversals in trends. In particular, divergence traders watch the lows and highs of price along with the lows and highs of the oscillator they are using. Below are four kinds of divergences in forex.
The first kind is called the regular bullish divergence, often used to identify a reversal in the ongoing downtrend. This happens because price is making lower lows but the oscillator is making higher lows, indicating that buyers have gathered enough energy to push the pair above its current selloff.
The next kind is the regular bearish divergence. This is formed when price makes higher highs but the oscillator makes lower highs. This is useful in pinpointing reversals also since price makes higher highs during an uptrend, but the formation of lower highs by the oscillator hints at a possible downtrend.
Third is the hidden bullish divergence. This takes place when the currency pair draws higher lows while the oscillator sketches lower lows. It is used in predicting a possible continuation of the current trend. Price has higher lows during and uptrend and a lower dip by the oscillator reflects more buying energy to take the pair higher.
The fourth kind is the hidden bearish divergence. This takes place when price makes lower highs but the oscillator sketches higher highs. This also predicts a continuation since price makes lower highs during a downtrend but the creation of higher highs by stochastic means that sellers have more momentum to push the pair down.
Take note though that there are several conventions when it comes to correctly identifying trading divergences. Some are stricter with their rules for marking highs and lows, as some want the oscillator to reach 80 to be called a high or to dip below 20 to be called a low.
The first kind is called the regular bullish divergence, often used to identify a reversal in the ongoing downtrend. This happens because price is making lower lows but the oscillator is making higher lows, indicating that buyers have gathered enough energy to push the pair above its current selloff.
The next kind is the regular bearish divergence. This is formed when price makes higher highs but the oscillator makes lower highs. This is useful in pinpointing reversals also since price makes higher highs during an uptrend, but the formation of lower highs by the oscillator hints at a possible downtrend.
Third is the hidden bullish divergence. This takes place when the currency pair draws higher lows while the oscillator sketches lower lows. It is used in predicting a possible continuation of the current trend. Price has higher lows during and uptrend and a lower dip by the oscillator reflects more buying energy to take the pair higher.
The fourth kind is the hidden bearish divergence. This takes place when price makes lower highs but the oscillator sketches higher highs. This also predicts a continuation since price makes lower highs during a downtrend but the creation of higher highs by stochastic means that sellers have more momentum to push the pair down.
Take note though that there are several conventions when it comes to correctly identifying trading divergences. Some are stricter with their rules for marking highs and lows, as some want the oscillator to reach 80 to be called a high or to dip below 20 to be called a low.