Divergence is a popular tool used by traders to find high probability trade setups. Divergence is simply a disagreement between the price movement and the indicator movement. For example, if the price action is moving up while the indicator is moving down, it is a divergence. Similarly, if the indicator is moving up and the price action is moving down, it is again a divergence. The indicator used in divergence trading are the MACD, Stochastics, RSI etc. In this article, we will discuss how to trade divergences using Stochastics.
Now, keep this in mind that divergence on a daily chart is quite different than the divergence on the weekly chart. Divergence on the daily chart means that the price will make a short term counter trend move in the next one to five days.
But a divergence taking place on the weekly charts means something more powerful. It means an intermediate trend change, something more powerful than a short term counter trend move on the daily charts.
Divergences do predict trend changes but it is important for you to realize that you can't simply buy or sell when the divergence takes place as the change does not happen instantly after the divergence. It can take sometimes for the trend change to happen. However, these divergence on the daily and the weekly charts can be traded very profitably if you know when to enter and exit.
A failure in divergence can take place when %K line changes direction but is unable to cross the %D line. In other words, %K line reverses back to the original direction without crossing %D line.
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