Divergence Trading Using Stochastics

Trading Strategy
This is a guest post by Ahmad Hassam

One of the most popular ways to use Stochastics is divergences. A divergence takes place when the price and the stochastics diverge from following the same path. For example, if the price makes a new low but the stochastics don’t, it is a divergence. In the same way, if the stochastics make a new high and the price doesn’t, it is again a divergence.

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.

Whereas a divergence on the weekly chart means that an intermediate trend change is about to happen. What this means is that if there is a weekly divergence, the counter trend move will be quite strong as compared to that on the daily chart. So, divergence on the weekly chart is a stronger signal as compared to that on the daily chart.

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 trend 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 occurs when the %K line changes direction but doesn’t cross the %D and reverses back to the original direction. If this happens, you should interpret it as a signal that the original trend will continue and you should continue in that direction.

Suppose, you are in a trade when you spot a divergence appearing on the Stochastics. Take profit for now by exiting your position. On the other hand suppose, you don’t have any position in the market. You spot a stochastics divergence appearing on the weekly charts.

As said before, divergences appearing on the weekly charts are far more powerful than those appearing on the daily charts. Expect a major retracement happening in the market soon. Look for entering into the market in the direction that the divergence is predicting.

In case you are long or short and you spot a divergence appearing simply exit the market on the first best opportunity like the appearance of the reversal bar pattern etc! Whatever, stochastics is an interesting technique. You can easily learn how to use them properly and profitably.

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