First of all I will talk about divergences.

Ok, all of you or most of you have heard about divergences.

Divergences are the most underrated or underlooked price patterns but trading divergences can give you a high rate of winning trades with high risk/reward rate.

For divergences we need an oscilator. Any oscilator will do but I use RSI with 14 period. I have used RSI with 9 period but is to fast. Many other traders use other oscilators but in my trading system I need RSI because I have created a money management based on it. You will read about this later.

Now, even if you know, let me give you a definition of a divergence: A divergence occur when the price is going or pointing in one direction and the oscilator is going/pointing in opposite direction.

Divergences occur in any time frame and you can trade it succesfully in any time frame as scalping in smaller time frames (5 min, 15 min, 30min) or as swing trades on bigger time frames (1 HR, 4 HR, daily).

What does a divergence tells us? A divergence tells us that a change in price/market direction will come.

Before I will show you how I trade divergences and most of it, how I enter into a divergence, let me show you a few examples of divergences:

As you see in the pictures above, we need two tops or bottoms on price and on the oscilator.

ENTRIES

Now comes the tricky part of the equation, the entries.

The entries are very important. If we have good entries we can manage the order in many ways.

As you see, in the grand scheme of things there are two kind of divergence (4 in fact with regular and hidden), negative divergences, when the price is going down and positive divergences when the price will go up.

I simply don't jump in the trade as soon as I see a divergence, I need a confirmation that the market has changed the structure from bullish to bearish in the case of negative divergences and from bearish to bullish in the case of positive divergences. For this confirmation I use a candlestick/chart pattern known as market structure.
There are two ways of entering this market structure and is up to you to choose one or another.

Entries for negative divergences:

I look at the last bullish candlestick and I consider the open of this last bullish candlestick. It can be the last bullish candlestick or it can be the last biggest or impulsive or marubozu-like candlestick. What is important is the open of this last bullish candlestick. Now, we wait for a bearish candlestick that will close under the open of last bullish candlestick and we enter at the close of this bearish candlestick. It is very important to respect this entry rule. Also it is very important to put a Stop Lose. The SL will be with 2 pips above the high of this price structure or 2 pips above the high of the bearish candlestick (the signal candlestick-entry candlestick) that closses below the open of last bullish candlestick.

For positive divergences we do in the opposite way as with negative ones:

We look at the last bearish candlestick or the last biggest or marubozu-like bearish candlestick and we pay attention to the open of this last bearish candlestick and then we wait for a bullish candlestick to close above the open of the last bearish candlestick and we enter. It is very important to put a SL and the SL will be with 2 pips under the low of the price formation or 2 pips under the low of the bullish candlestick (the entry-the signal candlestick) that closses above the open of the last bearish candlestick.

In the pictures bellow I show you the entries:

Now that we have the entries we need the exits and a good money or, in this case, order management.

Order size:

Rule one: Use only 1 or 2% of your capital for every trade and don't open more than 2 trades (different trades with different pairs) in the same time.

Rule two: Instead of using 2% I use 0.01 lot (1 microlot) for every 100 USD in my account (sometimes I use 0.02). So, if you have 1000 USD you use one minilot for all the open trades, so, if you want to open 2 trades you use half of a minilot for every trade. Don't open more than 2 trades at once (ok, you can open 3 if you want but for me is hard to manage 3 orders at once, especialy when I scalp with divergences).

Order management:

Here I have two rules too:

Take half of profit when the RSI line touches or crosses bellow or above the 50 level or take half of profit when you already have a 1 to 1 risk reward ratio and let the other half of profit runn and move the SL to entry (not necesarily!)

Rules for the other half of the order:

Exit when the price encounter a strong support/resistance and when the price will creat an opposite divergence or exit when the RSI line touches or crosses below the 30 level for negative divergences or above 70 level for positive divergences. Important is to stay in the trade/profit for as much as the price is giving you pips.

How to learn all of the above:

First, find this divergences and mark the entries, the SL and the exits.

Second, make at least 30 trades on demo before you jump on live.

Third, start trading divergences live only after you have mastered this in demo!

IMPORTANT RULE-IF THE DIVERGENCE IS NOT CLEAR FOR YOU, DON'T TAKE IT, PASS IT AND WAIT FOR ANOTHER DIVERGENCE!

How to trade Overbough/Oversold levels will be the subject of another blog post.

Ofcourse you are welcomed to comment and to ask questions.

Views: 1054

Comment by Glider on June 25, 2014 at 7:13am

Nice post Dao

Comment by Turjo on June 25, 2014 at 7:17am

Oh great Sir thank you so much it's really helpful.

Comment by JP on June 25, 2014 at 7:27am

Very Nicely explained. Its easy & effective. Great work Dao :)

Comment by Money Making Machine (MMM) on June 25, 2014 at 7:39am

thank you sir.

Comment by christian on June 25, 2014 at 8:14am

great post ! this really helps and put it all together in a nice and clean method

Comment by ERIC DANIEL on June 25, 2014 at 8:26am

Very educational article and simple to master.........thanks Dao for teaching to make money with minimum risk!!! Sharing is caring................

Comment by Kiramat on June 25, 2014 at 8:50am

Sir Dao is so nice man and good teacher but he dont like to teach people as he can teach us easily and people can get profit from his post.

Comment by Faraz Solangi on June 25, 2014 at 9:42am
Great post from great man,you are really a good teacher, here are a few members if someone ask something they will start insulting but you are most humble and helping member of this community keep it up the good work.
Comment by Money Making Machine (MMM) on June 25, 2014 at 9:56am

fara solangi u are right. i hope those people are reading this post.i am happy am learning not asking question  any more cause it pains when newbie ask question and they knock him out.some will tell you the opposite of there stand.all in all its good to learn and thats what am doing and big thanks to sir dao.i hope one day i will learn to become a pro.am learning so fast.will always give hand to the new ones.Respect Sir

Comment by Omkar Godbole on June 25, 2014 at 1:36pm

Thats great. Thanks for sharing your knowledge. I already learnt lot from you and the divergence trading is icing on cake. :) Thanks

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