As the name suggests, a divergence is a schism in the normal pattern that is expected to form in the market. Of course we are going to specifically focus on the forex market, so we will use examples from this market only. As a result, we can now say that divergence is a split that takes place that moves the price of a foreign currency pair from the direction or trajectory that the trader expected it would go.
Of course, on the face of it, a divergence is something that is unexpected. Something that you had not calculated for. Therefore, you would imagine that no trader would want to welcome a divergence. But on the contrary. If you know how to handle one, a divergence can be used to your advantage in the forex market.
What Exactly Is a Divergence?
In any market, including the forex market, there are clear trends and momentum trajectories. This means you can use technical indicators and technical analysis; you can find out the overall trend that exists in the market. For example, a bullish trend or a bearish trend.
But at some points, the price of a foreign currency pair might diverge and split from the overarching trend that exists on the chart.
So we can also say that a divergence occurs in the forex market, when the price of a currency pair moves away from the indicator that you have placed on the chart.
Naturally, if you are able to notice a divergence in due time and before it is too late, you can use this information in order to benefit from this sudden change instead of incurring losses as a result of it.
But how is that even possible? There are indicators that are specifically designed in order to be able to detect divergences in the forex market. Let’s take a look at these indicators.
Indicators to Detect Divergence in Forex
The thing you need to know about technical indicators is that other than the main purpose for which they are purported to have been developed, they can also be used for other purposes.
For instance, in this part we are mainly going to focus on oscillators. While oscillators are not solely developed for the detection of divergences in the forex market, we can also use them for that purpose.
First of all, an oscillator, as the name suggests, is a technical indicator that can show you a certain number of lines – no less than two, usually three. An oscillator is an indicator that oscillates – duh!
But why and how? The key feature of an oscillator is that its two upper and lower lines would naturally form a minimum and maximum threshold for the oscillator. And then there is another line that oscillates between the two lines. This provides valuable information for the trader.
The oscillators that are used in order to detect divergences in the forex market are as follows:
This oscillator is mainly used in order to detect the speed with which prices can change in the forex market. In addition to the speed of price change, the Stochastic can show the momentum of price change in the market. The main notion behind this oscillator is that it does not solely go with the price, it mainly goes along with the volume registered in the market.
Relative Strength Index
The relative strength index, which is also referred to as RSI, is another oscillator that is mainly used in order to specify momentum in the market in addition to the speed of price changes. It can also show the states of overbuying and overselling in the market.
Moving Averages Convergence and Divergence
This is another oscillator that is used in the detection of trend and momentum. As a result, it is classified among the group or class of technical indicators known as trend indicators or momentum indicators.
Williams R Percentage
This indicator which is known as Williams percent R, Williams %R, or Williams R percentage is an oscillator that falls within the group of momentum indicators. It is the exact opposite of the Stochastic oscillator. So its digits and numbers are the exact opposite of the Stochastic.
While there are many other technical indicators that can potentially be used in the detection of divergence in the forex market, these four indicators that we have just discussed are the main indicators used in this regard.
How to Track Divergence in Forex with Oscillators?
As we said, divergence in the forex market includes the split that is seen between the price movement of a currency pair and its major trend or momentum that exists on the chart.
The way you can use oscillators in order to detect any divergence in the forex market is actually really straightforward. When the major trend in a market is a bullish one, then it should be expected that the oscillator would register higher highs as the price follows the trend.
At the same time, if there is a major bearish trend in the market, the oscillator ought to register lower lows as the prices fall further to the bear territory.
These two scenarios are the normal tendency that you would expect to see. If the price action moves away from the trajectory of the oscillator at any point, that is when we have a divergence in the market.
How to Benefit from Divergence in Forex
There are certain steps that you need to follow in order to make sure that, first, the divergence that you have detected is correct, and, second, that you will definitely be able to benefit from this process.
First, you need to make sure that the trend you have detected is correct. So for this purpose you need to utilize the exactly correct trend indicators.
In addition to that, you also need to find out the levels of support and resistance. These two lines are extremely crucial, because the higher highs and the lower lows play an essential role in the detection of breakout from the trend line.
After that you can monitor the chart in order to detect the occurrence of divergence. Once you detect that a divergence has indeed taken place, then you need to see what the type of divergence is.
Has the divergence occurred within a bullish trend or within a bearish trend? This is also very important because that would define the trajectory of the divergence itself.
You need to know the direction of the divergence in the first place in order to be able to capitalize on it. If you don’t know the trajectory of divergence, then naturally you would not be able to profit off of it.
Divergence is one of the most important notions that occurs on any chart. In the forex market, a divergence is the split that occurs between the trajectory or direction of the price of a currency pair and the trajectory of the trend line. If you are able to detect the occurrence of the divergence, then you can use that to your benefit.