Divergence Indices Trading Setups
Divergence is one of the trade set ups used by traders. It involves looking at a chart and one more indicator. For our examples we shall use the MACD indicator.
To spot this trading setup find two chart points at which price makes a new swing high or a new swing low but the MACD indicator doesn't, indicating a divergence between price & momentum.
To search for divergence we look for two chart points, two highs that form an M-shape on the Stock Indices chart or two lows that form a W-Shape on the Indices chart. Then look for same M-shape or W-Shape on the Indices indicator you use to trade.
Example of a Stock Indices Divergence Trade Setup:
In the chart below we spot two chart points, point A and point B (swing highs). These two points form an M-shape on the price chart.
Then using MACD indicator we check highs made by the MACD, these are highs that are directly below Chart points A and B.
We then draw one line on the Stock Indices chart & another line on the MACD indicator.
Drawing Divergence Indices Trading Lines
The chart above highlights example of one of the four types of divergences, the one above is referred to as hidden bearish divergence, one of best type to trade. Types of divergences are covered in the next tutorial.
How to spot divergence
In order to identify Indices diverging signal we check for the following:
- HH=Higher High- two highs but last one is higher
- LH= Lower High- 2 highs but last one is lower
- HL=Higher Low- 2 lows but last one is higher
- LL= Lower Low- 2 lows but last one is lower
First let us look at the illustrations of these terms:
M-shapes dealing with price Highs
W-Shapes dealing with price lows
Example of M-Shapes
Examples of W Shapes
Now that you have learned the divergence terms that are used to explain set-up. Let us look at the two types of divergences & how to trade these chart setups.
The two types are:
- Classic Stock Indices Trading Divergence
- Hidden Indices Trading Divergence
These 2 setups are described on following guides below
