How to identify hidden divergence signals
The figure below shows the bearish hidden divergence, with prices making lower highs but oscillating indicators making higher highs:
Bearish hidden divergence is a signal that helps traders identify a potential return with a high probability of returning to a downtrend.
Principle of entering and exiting orders with bearish hidden divergences
There are 2 trading setups with bearish hidden divergence, one uptrend and one in a downtrend. In these 2 setups, we both use the EMA 20 and the 50 EMA.
The figure below is in a downtrend:
The principle is as follows:
- The 20 EMA is below the 50 EMA and the price is operating below the 20 EMA.
- When the above conditions are met, we find a pullback to the EMA and form a lower high. In this pullback, the price needs to close above the 20 EMA, and after that price pulls back to close below the 20 EMA.
- When the price has formed a lower high, we check for divergence on the stochastic. If so, it is a sell signal.
- Open a short position with the candle closed below the 20 EMA or place a sell limit above the closing price to get better entry points.
- Stop loss above the lower high, and take profit at a 1: 2 ratio. When the take profit is reached, we can move the stop loss to breakeven and take a portion of the profit.
The figure below is a hidden divergence in an uptrend:
The principle is as follows:
- The 20 EMA should be above the 50 EMA, and the market is trading above the 20 EMA.
- Wait for the market to form a lower high.
- Then check the stochastic for hidden divergence forming or not.
- Then wait for the price to close below the 20 EMA and then back up above the EMA.
- Open a short position at the close of the bearish candlestick below the 20 EMA or place a sell limit above the closing price for better entry points.
- Place stop loss above the lower high, and take profit at 1: 2 ratio.
Let us now go through a few examples.
Example 1: EUR USD in H1 frame
Here is a signal of hidden divergence on a downtrend:
- We see the 20 EMA is below the 50 EMA and the market is also working below the 20 EMA.
- First, bounce back to 20 EMA and back. At this point, there is no hidden divergence, but a lower high. But the second recovery closed above the 20 EMA but then turned down for 2 candles and closed below the 20 EMA forming the next lower high.
- At this time, the stochastic showed signs of hidden divergence.
- Open a short position at 1.0950.
- Place stop loss at 1.0965 (15 pips) and take profit at 30 pips.
And the figure below is the next chart part:
Example 2: USD JPY in H1 Frame
Divergence is hidden in an uptrend:
- On the left side of the chart, you can see that the price is in an uptrend.
- Then the market fell below the 2 EMA and then increased again. At this time, 20 EMA crosses above 50 EMA, showing a trend change.
- Then the market turned back below the 2 EMA and closed below it and made a lower high.
- Check on the stochastic for hidden divergence appearing or not. If so, it is our sell signal.
- The market closed close to 113.40. You can place the sell limit at 113.40.
- Stop loss at 113.60 (about 20 pips). Take profit of 40 pips.
And the figure below is the next chart:
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