Due to the forex market's complexity, it is hard to find an optimum indicator to foresee the potential development of market trends, if any such indicator exists at all. However, forex divergence may be one of the best indicators to reveal how the market may behave in the periods to come, thereby providing the investor with the opportunity to make the best justified trading decisions. Divergences may be a signal of a trend reversal or in some cases, a temporary change of direction in a longer-term trend.
One of the most powerful trading signals that combines price action analysis with the use of indicators is the divergence signal. To diverge means to move or draw apart. When a currency pair is converging, it means that price and momentum are in sync with each other and price is moving at a sustainable pace. When a currency pair is diverging, it means that price and momentum are not in sync with each other and action is moving in a less stable/sustainable pace and the likelihood of a correction or even reversal increases.
Divergence helps the trader recognize and react appropriately to a change in price action. It tells us something is changing and that the trader must make a decision about the trade, such as tighten the stop-loss or take profit. Seeing divergence increases profitability by alerting the trader to protect profits. Divergence indicates that something is changing, but it does not mean the trend will reverse. It signals that the trader must consider strategy options: holding, selling a covered call, tightening the stop or taking partial profits.
Divergence strategies can be very useful and profitable in forex trading. Divergence basically means moving in different directions. In terms of trading, divergence occurs when the price goes in one direction, while an indicator – appropriately enough, called a divergence indicator – turns in a different direction. Forex traders utilize divergence indicators such as the relative strength index (RSI), the stochastic index and the moving average convergence divergence indicator (MACD). The MACD is one of the most popular divergence indicators among forex traders.
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. The divergence indicator in forex may be an essential tool for traders to identify signals of close market trend reversal. Through the effective use of forex divergence, to may be able to avoid possible losses and maximize your profits.