How To Trade A Divergence – A Step By Step Divergence Trading Guide

Advertisement - External Link

How To Trade A Divergence – A Step By Step Divergence Trading Guide

Divergences are one of my favorite trading concepts because they offer very reliable high-quality trading signals when combined with other trading tools and concepts.

Although indicators are somewhat lagging – just like price action is lagging too – when it comes to divergences, this lagging feature is actually going to help us find better and more reliable trade entries as we will see below. Divergences can not only be used by reversal traders but also trend-following traders can use divergences to time their exits.

In my own trading strategy, divergences are a big part for one of my setups and in combination with other signals. I do not recommend trading divergences by themselves but they are a good starting point.


What is a divergence?

Let’s start with the most obvious question and explore what a divergence really is and what it tells you about price. You’d be surprised how many people get this wrong already.

A divergence forms on your chart when price makes a higher high, but the indicator you are using makes a lower high. When your indicator and price action are out of sync it means that “something” is happening on your charts that require your attention and it’s not as obvious by just looking at your price charts.

Basically, a divergence exists when your indicator does not “agree” with price action. Granted, this is very basic and we will now explore more advanced divergence concepts and see how to trade them, but it’s important to build a solid foundation.


Bearish and bullish divergence. Price and indicator are out of sync. Divergence foreshadows reversal.


An RSI divergence

#1 Revisiting the RSI

Divergences work on all indicators, but my favorite by far is the RSI (Relative Strength Index). The RSI compares the average gain and the average loss over a certain period. So for example, if your RSI is set to 14, it compares the bullish candles and the bearish candles over the past 14 candles. When the RSI value is low, it means that there were more and stronger bearish candles than bullish candles over the past 14 candles; and when the RSI is high it means that there were more and larger bullish candles over the past 14 candles.


#2 When does an RSI divergence form?

Understanding when your indicator is high or low is important when it comes to interpreting divergences and I generally encourage traders to look beyond the squiggly lines of their indicators to explore what it really does.

During trends, you can use the RSI the compare the individual trend waves and so get a feeling for the strength of the trend. Here are the three scenarios and the screenshot below shows every single one:

(2) Typically, the RSI makes higher highs during healthy and strong bullish trends. This means that there were more and larger bullish candles in the most recent trend wave than there were compared to the previous wave.

(1) When the RSI makes similar highs during an uptrend it means that the momentum of the trend is unchanged. When the RSI makes an equal high, it does not qualify as a divergence because it just means that the strength of the uptrend is still up and stable. Higher highs on the RSI do not show a reversal or weakness. It just means that the trend is progressing unchanged.

(3) When you see that price is making a higher high during a bullish trend, but your RSI makes a lower high, it means that the most recent bullish candles were not as strong as previous price action and that the trend is losing momentum. This is what we call a divergence and in the screenshot below, the divergence signaled the end of the uptrend and it makes a downtrend possible.



#3 Conventional technical analysis is flawed

Classic technical analysis tells us that a trend exists when price makes a higher high – but like too often, conventional wisdom is seldom right and usually simplifies things too much. A trader who only relies on highs and lows for his price analysis often misses important clues and does not fully understand market dynamics. Even though a trend could look “healthy” at first glance (higher highs and higher lows), it might be losing momentum at the same time when we look deeper at the candles and the momentum.

Spotting a divergence on your momentum indicator, thus, tells you that the dynamics in the trend are shifting and that, although it could still look like a real trend, a potential end of the trend could be near.


How to trade a divergence – the optimal entry

A divergence does not always lead to a strong reversal and often price just enters a sideways consolidation after a divergence. Keep in mind that a divergence just signals a loss of momentum, but does not necessarily signal a complete trend shift.

To avoid trade entries that don’t go anywhere, I highly suggest you add other criteria and confirmation tools to your arsenal. A divergence alone is not something that strong enough and many traders experience bad results when trading only with divergences. Just like any trading strategy, you need to add more confluence factors to make your strategy strong.

Below we see how price made 2 divergences but price never sold off. The divergences, thus, just highlighted short-term consolidation.





Tip: Location

Location is a universal concept in trading and regardless of your trading system, adding the filter of location can usually always enhance the quality of your signals and trades. Instead of taking trades just based on a divergence signal, you’d wait for the price to move into a previous support/resistance zone and only then look for divergences and trend shifts to time entries.

The screenshot below is a great example: On the left side, you see an uptrend with two divergences. However, the first one completely failed and the second one resulted in a massive winner. What was the difference? When we take a look at the higher time frame on the right we see that the first divergences happened in the middle of nowhere and the second divergence formed at a very important resistance level (yellow line and yellow arrow). As a trader, you first identify your support/resistance zones and then let price come to you. Such an approach will impact your performance in a big way.


Divergences are a powerful trading concept and the trader who understands how to trade divergences in the right market context with the correct signals can create a robust method and effective way of looking at price.




A main reason why traders fail to find profitable trades is because they don’t fully understand the nature of price
Following up with my last swing trading article, today I want to go a bit into detail about a particular
I show you how to trade price action the right way. I have been trading for over 14 years and
Preserving emotional capital is often more important than protecting your financial capital. A trader who loses his emotional capital is
News and fundamentals are a very controversially discussed topic among traders, but even if you are not a fundamental trader,
How often has this happened to you that you somehow knew what price was going to do, but you still

Comments ( 25 )

  • Daniel

    Good article. You got a missing picture in the page..

    • Rolf

      Thanks, Daniel. Just fixed it 🙂

  • Ерж

    Thank You, Rolf! Good article, especially these comments : When we take a look at the higher time frame on the right we see that the first divergences happened in the middle of nowhere and the second divergence formed at a very important resistance level (yellow line and yellow arrow). As a trader, you first identify your support/resistance zones and then let price come to you. Such an approach will impact your performance in a big way.Very helpful to master the market!

  • Oussama Mansour

    good job , thanks for all

  • Ashley

    Simplistic and usefull info thanks once again

  • Sfiso T Ngema

    Wow! Great piece of information…. great work my guy.

  • Godwin

    God bless great teacher like you, good article from you, keep it up

    • Festus

      Thank you for the article, it’s quite educative and an Eye-opener.

  • Damian

    To date i have not found a trading strategy with a higher winning percentage than divergence combined with support and resistance levels.

    Excellent and on point article.

  • Monkey

    Great article Rolf, and great examples, Thank you

  • B,R,Singh (India)

    Thanks Rolf for this interesting article. I was aware of this but you showed me the correct way. This article will surely help me in my trading strategies.Thanks

  • Martin

    Thank You Rolf! Good article.

  • Edward

    Personally I cannot trade divergences as they will always happen when a market is very strong (or very weak). This is because price can keep making higher highs (or lower lows) but the indicator cannot as it has levels that it cannot go beyond. They are so common that you will get stopped out repeatedly.

    • Akbar

      thats why we need to draw support and resistance area first

  • Yoshita

    Thank you Rolf, this realistic and smart article has shown the way and greatly benefited me, thank you again

  • Unlipips

    Thanks for sharing! One of the best way to enter a divergence is when rsi breaks level 50.

  • Venkateswaran V

    Dear Rolf,
    I happen to see your article when I was browsing for divergences, I personally a strong believer in trading with divergences and I just always wonder why many times my divergences based trades were failed and now I understood clearly that combining the divergences along with support and resistance is something more crucial for spotting winning trades.

    Thanks a trillion for enlightening me.

  • Mayur

    Excellent article. Thank you

  • Random

    Well explained article.Thank You.

  • Bharzert Agoe

    I’m impressed. Very useful divergence trading tips. I always cherish your articles

  • Anonymous

    Thanks so much, this is great

  • Egleyd

    Thanks so much, Rolf!!! Yours articles are amazing!

  • Purushottam Fegade

    Well explained… Thank you Rolf…

  • ChukwuEbuka Dike

    Love it keep it up

  • Kat

    There are 2 sorts of divergences: a regular one and a hidden one. Also 2 or 3 divergences following the one after the other gives better ” chances” of a good trend reversal

Advertisement - External Link

Cookie Consent

This website uses cookies to give you the best experience. Agree by clicking the 'Accept' button.