Trading strategy with divergence for stock market

Wonder What a expert Trader sees in the 2008 crisis and Covid 19 crisis. He sees the divergence in the chart of Nifty50. When others were losing money in the crash an expert trader was making profit with the divergence trading strategy.

If you look at the chart of Nifty50 back in 2008 and 2020 when prices start dropping you can easily spot a divergence with the help of RSI.

So What does divergence trading mean? Divergence trading is a most known and profit making strategy of technical analysis.

Divergence occurs when the price of a stock moves in the opposite direction of the technical indicator basically oscillator (mostly uses RSI and MACD). Divergence is a warning about the future event in price. It tells that the current trend in price has started getting weak and a reversal of the trend may start.

 

Does Divergence trading work?

Yes, Divergence trading works and is one of the most profitable trading techniques and can generate massive profit. Divergence helps traders to see the next move of price. It helps the traders to take the decision and react appropriately to the change in the momentum of price. It tells traders that the price is losing its momentum in the current trend and it might reverse or consolidate. It warns traders about the future price action and helps to take the right decision and protect the profits.

There are two types of divergence in trading - negative and positive.

Positive Divergence - It occurs when the price makes new lower lows consecutively and the oscillator makes new higher lows. It signals that the current downtrend in the stock is weakening and the reversal in price may start soon.

Negative Divergence - It occurs when the price makes higher highs and the oscillator makes lower highs consecutively. It signals that the current uptrend in the stock is weakening and the reversal in price may start soon.

How to trade divergence?

Divergence trading is one of the most profitable strategy and can generate massive profits. One can use many indicators to spot the divergence but most effective are oscillators like RSI.

And the best indicator for divergence trading is RSI. RSI spots the divergence better than other indicators and is more reliable than any other indicator to spot the divergence.

Like any other strategy, divergence can sometimes be misleading and give false signals. By using the higher time frame to spot the divergence can reduce flaws and false signals and give reliable and profitable trades. As one decreases the time frame to trade the noise gets louder and becomes difficult to spot the reliable divergence.

Divergence trading strategy does not give the entry and exit points. It only tells about the future price trend. To get the entry and exit one can use other technical indicators and techniques like Support/Resistance Strategy, Trendlines, candlestick and chart patterns.

 

How to spot divergence with RSI?

If in a downtrend, price is making lower highs and lower lows and the RSI is making higher highs and higher lows, it signals that the momentum in price is started weakening at bottom and it might reverse its direction. This is the positive divergence.

 

If in an uptrend, price is making higher highs and higher lows and the RSI is making lower highs and lower lows, it signals that the momentum in price is started weakening at top and it might reverse its direction. This is the negative divergence.

 

Points to remember :

Using divergence alone to predict the price reversal may not be very effective because divergence tells that price has lost its momentum in the current trend but it does not tell When? Or for how long the price will reverse? It may take some time or happen soon. If a stock is in a strong uptrend and a negative divergence occurs, it tells that the current trend in price has lost its momentum but it does not mean the current trend has ended. Price may consolidate or correct but it will follow the main trend. So trading on the sole basis of divergence can result in many loss opportunities.

Divergence only tells that price has lost its momentum; it does not give entry or exit points and also fails many times like other strategies. To perfect the trades and lock in the profits one must look for divergences but never use it solely to trade the stocks. Use it with other trading techniques.

 

Conclusion :

Divergences are a widely used strategy for trading in the stock market. It tells the direction of the future price action and positive or negative movements in the stock price. Divergence works better with the oscillators like RSI and can be very profitable. To use the divergence more effectively one must use it with other trading tools like trendlines, fibonacci retracement and candlestick and chart patterns on a higher time frame to perfect the trade and get the entry, exit, stop loss and target points.