Learn Forex: Trade Stochastics With Hidden Divergence

DailyFX

Article Summary: Stochastics can be used for more than just crossovers. To find better entries in trending markets, traders can employ a hidden divergence trading strategy.

Normally traders look at the Stochastics indicator as just another oscillator used for its overbought/ oversold values and momentum crossovers. This is for good reason since these values can be extremely useful in both trending and ranging markets. However another alternate use for Stochastics in trending markets can be to spot hidden divergence.

Hidden divergence is an exceptional market tool that can pinpoint areas to enter the market and eliminate some of the guesswork created by false trading signals. Below you can see the EURGBP daily chart that has advanced as much as 712 pips over the course of the last five trading months. Since price momentum has advanced so rapidly we can turn to hidden divergence to identify potential entry points.

Learn Forex – EURGBP Daily Trend

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Learn_Forex_Trade_Stochastics_With_Hidden_Divergence_body_Picture_2.png, Learn Forex: Trade Stochastics With Hidden Divergence

(Created using FXCM’s Marketscope 2.0 charts)

Divergence by definition implies that two things are separating. That is actively what we will be looking for on our EURGBP 1 Hour chat below. Normally when the EURGBP advances Stochastics should be advancing as well. Hidden divergence in a bull market occurs when price continues to trend higher but our indicator moves lower.

To begin analyzing hidden divergence in an uptrend we need to begin with identifying the current lows of price. In an uptrend, our lows should be advancing making higher lows on the graph. Next we will need to compare Stochastics for the same period. Marked below we can see the indicator creating a series of lower lows. This is hidden divergence! Now that hidden divergence is spotted traders will often proceed to execute on either a crossover or return from oversold values in expectations that the trend will move to higher highs.

Learn Forex – EURGBP Hidden Divergence

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Learn_Forex_Trade_Stochastics_With_Hidden_Divergence_body_Picture_1.png, Learn Forex: Trade Stochastics With Hidden Divergence

(Created using FXCM’s Marketscope 2.0 charts)

It is important to note that indicators can stay overbought and oversold for long periods of time. As divergence trades may develop over a longer time frame, traders should always look to contain risk by the use of a stop order. One method to consider in an uptrend is to employ a stop underneath the current swing low in price.

---Written by Walker England, Trading Instructor

To contact Walker, emailwengland@fxcm.com. Follow me on Twitter at @WEnglandFX.

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