I was told once, that there are over a hundred ways to enter the market. We only need to find the particular entries that work for us individually and master them so that they become second nature. We then become practiced at recognizing the good entries and avoid the bad entries, while constantly improving our technique.
The following is an example of trading with Divergence, try it and see if it is a good strategy for you:
Determine Market Condition
Before entering the market, the first step is to determine the market condition of the currency pair in question. Is it trending bull (up), bear (down), or lamb (sideways)? Start with the larger time charts to get an overview of what the overall direction of the market is doing. I like to trade on the 1 hour chart, but look at the Day chart first, then drill down to the 4 hour, before analyzing the 1 hour. Then, look also at a smaller time compression such as the 30 min or 15 min to verify immediate market direction.
For demonstration purposes of this strategy, I am using the EUR/USD. First, we look at the Day chart. Here we see the market in the larger compressions is trending downward. The Day chart is considered the “truth” chart meaning that trades in the smaller compressions that follow the same direction as the Day chart have a greater degree of safety.
Next, let’s look at the 4 hour chart. Here, we see an upward or bull trend, yet at the same time we’re seeing some initial signs of market reversal as indicated by Negative Divergence. In this example, MACD indicators are used, with standard settings (12, 26, 9).
Step 2 Begin Analysis
Now we’re ready to drill down to the 1 hour chart and begin our analysis for entry and exit points. In the chart below, we see the existing uptrend and the Negative Divergence verified from the 4 hour chart. Since we’re basing our analysis on higher highs from the price action and lower highs on the MACD, we can hypothesize that the market will soon make a trend reversal. With the Day chart in a downtrend, we have a greater degree of safety in entering the market bearish.
Step 3 Define Entry and Stop Limit
Ok, so now that we have defined projected market direction and have a fair degree of safety, the next step is to define our entry point. To do this, we wait for the market to come to us. Never, never, never chase the market. We have made our analysis, now we enter when the market proves our theory. In a bull trend such as this, the trend has naturally created strong support areas as indicated below.
We now draw our trend-line along the supports. When the market breaks below our trend-line, the current trend has been broken, and we would enter short. In this example, our entry would be around 1.3252. Our stop limit would depend on risk tolerance, but if the market is going to continue bear, it is unlikely to break above the most recent high. In this case, we would put our stop as indicated, about 3-5 pips above the highest recent resistance, or at 1.3285.
If this stop has a large pip spread and you want to find a tighter stop limit, you can drill down to a smaller time compression and look to the left for other resistance levels.
Step 4 Define Exit Point
So now you’re in the market and you’re waiting to see your profits, but how far will the market go and when should you get out to maximize your profits? This is the million dollar question. There are two ways to proceed from here, depending on how much time you have and if you can watch the market or if you have to walk away. Both strategies will start the same way, which involves some calculations (I know, the dreaded “math”…but please don’t shoot the messenger). I like to plot my exit points by creating parallelograms. Draw the first line of the parallelogram off the previous downtrend. The top of the parallelogram is plotted to the next resistance created in the subsequent uptrend. The point of the parallelogram creates a new support area and potential reversal point. See illustration below. You can also exit at the next pivot line depending on your tolerance level and pip goals.
If you can watch the market, rather than exit, you can attempt to maximize profit by staying in the market longer. Keep an eye on the indicators to see if the trend is showing new divergence for market reversal. Instead of exiting, move your stop limit down to your former exit area. Now, even if the market reverses, you keep the same profit you would have should you have exited. Recalculate your exit level and continue to do so until indicators reverse or stop is hit. In this example, our entry was at 1.3252 and our exit was at 1.3145 for a gain of 107 pips.
Choosing the best exit point is sometimes the biggest enigma, so if you have any suggestions to add to this strategy, I welcome your comments. As always, when learning a new strategy, I recommend testing it out on your practice account until you get familiar with the signals and see consistent returns before going live. Experiment with the indicators used, the time compression that works for you, and the best exit points. Let me know how it works for you.
A very clear and educational post which I enjoyed reading. Thanks Rebecca.
Very well explained. I like to way you plot your exit by creating parallelograms. thanks for sharing.