There are two different types of trading strategies that lie on opposite sides of the spectrum. One is a continuation type of strategy, while the other is a reversal type of strategy. Just by how they are called, you would intuitively understand that they are complete opposites. One trades in the same direction as the most recent trend or momentum, while the other trades on an anticipation of a reversal from a prior trend or momentum.
Continuation type of strategies, such as trend following strategies, tend to have the advantage of having a high win probability. This is natural because we are not fighting against the trend or momentum hoping to catch the bottom or the high.
Reversal type of strategies on the other hand have the tendency to produce trades with relatively high risk-reward ratios. This is because if the trend or momentum does reverse, that would mean we have made a trade at the beginning of the new trend or momentum pulse.
What if we could trade with the trend while still trading a reversal type of strategy. Yes, it is possible that these two opposing types of strategies can be combined into one strategy. This is because the market is a series of short-term and long-term trends. We can trade a short-term reversal that agrees with the direction of the long-term trend.
Divergence trading strategies are an example of a reversal type of trading strategies. However, there is a type of divergence pattern, particularly the hidden divergence pattern, which typically occurs as a reversal pattern that agrees with a long-term trend. Let us discover how we can make use of this concept in order to trade with the trend while trading a reversal type of setup.
Divergence and Hidden Divergence
Table of Contents
- 1 Divergence and Hidden Divergence
- 2 Moving Average Convergence and Divergence
- 3 Multi Oscillator Divergence Indicator
- 4 200 Simple Moving Average
- 5 Conclusion
If you would observe how the market moves, you would notice that it moves in a series of waves. These waves have swing highs and swing lows which form the peaks and troughs of a wave. Oscillator type of indicators tend to mimic the movement of price action while plotting the oscillations in its own oscillator window. As such, oscillators also create peaks and troughs as it mimics the movement of price action.
Divergences are market conditions wherein there is a discrepancy with the height or depth of the peaks and troughs between that of price action and that of its corresponding oscillator indicator. It has been observed that these divergences tend to be followed by a strong reversal. As such, many traders have used divergences as a basis for a reversal type of strategy and many have found success doing this type of strategy.
Below are the different types of divergence patterns.
Among these different types of divergences, the Hidden Divergence is one which is very interesting. This is because this type of divergence tends to occur as a trend continuation signal right after a deep retracement. The discrepancy occurs whenever the peak or trough on the oscillator tends to be exaggerated while the peak or trough formed on the price chart tends to be shallow since it is just a retracement.
Moving Average Convergence and Divergence
The Moving Average Convergence and Divergence (MACD) is a widely used oscillator type of technical indicator, which is based on an underlying crossover of moving averages.
The MACD computes for the difference between two Exponential Moving Average (EMA) lines. It then plots the difference as histogram bars or as the MACD line. A positive figure indicates a bullish trend bias, while a negative figure indicates a bearish trend bias.
It also computes for the Simple Moving Average (SMA) of the above mentioned MACD line. This moving average derived from the MACD line is called the Signal Line. A MACD line crossing above the signal line indicate a bullish momentum shift, while a MACD line crossing below the signal line indicate a bearish momentum shift.
The MACD is one of those indicators that tend to work well with divergences. As such, we will be using this MACD as the basis for our Hidden Divergence setup.
Multi Oscillator Divergence Indicator
The Multi Oscillator Divergence indicator is a reversal signal indicator based on the concept of divergences.
It practically plots the lines to show the divergences between price action and the chosen type of oscillator. It plots dotted lines to indicate a hidden divergence, and solid lines to indicate a regular divergence. It plots the lines below price action to indicate a bullish divergence, and above price action to indicate a bearish divergence. It also conveniently plots an arrow pointing the direction of the potential reversal.
This indicator also allows traders to choose between different types of oscillator indicators, as well as the parameters of the chosen oscillator.
Multi Oscillator Divergence Variables Modified
- Oscillator/Indicator to use: MACD
200 Simple Moving Average
The 200 Simple Moving Average (SMA) line is a widely used moving average line. It is used by traders as a basis for the long-term trend.
The long-term trend direction is based on the location of price action in relation to the 200 SMA line, as well as the slope of the line.
Moving Average Variables Modified
- Period: 200
- Method: Simple
Bullish MACD Divergence Setup
- Price action should be above the 200 SMA line.
- The 200 SMA line should slope up.
- The Multi Oscillator Divergence indicator should indicate a hidden bullish divergence.
- Place a buy stop order above the candle where the hidden bullish divergence is formed.
- Set the stop loss on the support below the entry candle.
- Set the take profit target at the most recent swing high.
Bearish MACD Divergence Setup
- Price action should be below the 200 SMA line.
- The 200 SMA line should slope down.
- The Multi Oscillator Divergence indicator should indicate a hidden bearish divergence.
- Place a sell stop order below the candle where the hidden bearish divergence is formed.
- Set the stop loss on the resistance above the entry candle.
- Set the take profit target at the most recent swing low.
Hidden divergences are peculiar market conditions. This is because it is a reversal type of condition, which typically occurs in the direction of a long-term trend. This makes hidden divergences a very high potential type of trade setup.
MACD based divergences also tend to be reliable. Although it is possible to use a regular MACD indicator and subjectively identify the divergences, this indicator simplifies the process as it identifies the divergences for you. All you need to do is to quickly look at the indication and check if you agree with what the indicator identified.
Forex Trading Strategies Installation Instructions
Simplified MACD Trend Divergence Forex Trading Strategy – MT5 is a combination of Metatrader 5 (MT5) indicator(s) and template.
The essence of this forex strategy is to transform the accumulated history data and trading signals.
Simplified MACD Trend Divergence Forex Trading Strategy – MT5 provides an opportunity to detect various peculiarities and patterns in price dynamics which are invisible to the naked eye.
Based on this information, traders can assume further price movement and adjust this strategy accordingly.
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How to install Simplified MACD Trend Divergence Forex Trading Strategy – MT5?
- Download Simplified MACD Trend Divergence Forex Trading Strategy – MT5.zip
- *Copy mq5 and ex5 files to your Metatrader Directory / experts / indicators /
- Copy tpl file (Template) to your Metatrader Directory / templates /
- Start or restart your Metatrader Client
- Select Chart and Timeframe where you want to test your forex strategy
- Right click on your trading chart and hover on “Template”
- Move right to select Simplified MACD Trend Divergence Forex Trading Strategy – MT5
- You will see Simplified MACD Trend Divergence Forex Trading Strategy – MT5 is available on your Chart
*Note: Not all forex strategies come with mq5/ex5 files. Some templates are already integrated with the MT5 Indicators from the MetaTrader Platform.
Click here below to download: