Using Divergence for Entry and Exit Strategies

Using Price Action Strategy

Using Divergence for Entry and Exit Strategies

Divergence is highly effective when you are looking to plot entry and exit points as part of your overall trading strategy. Mainly divergence can signal at what point you can get in and at what point you should get out. It should be noted that the perfect entry point is the lowest possible point during a bearish trend. In contrast, the ideal point to get out would be the highest possible point during a bullish trend. In either of these cases, you would ideally get in or out right before the change in trend takes place. This is what can allow you to maximize your profit either way. So, let’s take a look at how you can capitalize on this situation.

First, let’s start with a bearish trend.

By definition, a bearish trend implies that the overall price action is trending downward. Even if you have significant spikes along the way, you can determine your trendline to be a downward slope. When this occurs, you need to spot when the trend will reverse.

The main point of playing a bearish trend is trying to determine the entry point of a trade setup. As such, you are looking to find the lowest possible point, right before the trend is about to reverse. Theoretically, this is the point where the trendline intersects with the lowest point of the price action. However, this point needs to be at least at the lowest point of the support level.

Consequently, the first step toward making this strategy work is to clearly identify the support level. A double bottom would be a great indicator that this setup will work effectively. You might try to go on a single breakthrough. However, that’s not enough confirmation that the trend will reverse. That would constitute a false signal. Therefore, a double bottom is the best indicator. If you happen to see a triple bottom without the trendline intersecting, then you are getting ready for a huge takeoff.

Your entry point will be revealed when you spot the exact intersection of the trendline with the support level. This is where you can enter the trade. Then, you can expect the price to take off. The exit point is determined by your risk to reward ratio. You can set your exit anywhere from 20 to 60 pips above your entry. However, it would be recommended that you double check previous highs. This will give you the best indication as to where you can reasonably expect the high to hit.

Now, let’s take a look at this strategy based on a bullish trend.

The whole point of this strategy is to figure out the best exit point. This exit point is intended to maximize your profit. Thus, the objective is to leave the trade at the highest possible point right before the trend reverses.

To do this, it’s important to identify the resistance level. Ideally, you would have a double top you can use as a reference point. If you have a double top in which one of the points broke out of the resistance level band, then you may be seeing a false signal.  This is generally due to increased trading volume. To make this setup work appropriately, you need to make sure that the double top stays at or very close to the resistance level. If you cannot spot a breakout after a triple top, then the downtrend will be quite sharp. So, it might be a good idea for you to set up your exit point slightly before the resistance level limit. 

In both cases, it’s important to automatically setup stop-loss and take-profit points as this will ensure that you don’t fall asleep at the wheel. This is especially important if you don’t plan to be physically present at your terminal. In such cases, the market orders will be triggered automatically once your specific point is triggered. Please keep in mind that setting up your take-profit and stop-loss points automatically will save you a lot of headaches further down the road.