Now it’s time to put those divergence-spotting skills to work and look to capture some pips.
In the previous lessons, you learned what regular and hidden divergences are and why they happen.
Now we’ll show you some examples of when there was a divergence between price and oscillator movements, and walk through how a trader might think about each setup.
One important thing before we dive in: These examples show trades that worked.
That’s great for learning the concept, but remember that NOT every divergence leads to a clean reversal or continuation.
The goal here is to train your eye to spot these setups and understand the thinking behind them.
We’ll cover the rules for filtering out the bad signals in a later lesson.
How to Trade a Regular Divergence
First up, let’s take a look at regular divergence.
Below is a daily chart of USD/CHF.
We can see from the falling trend line that USD/CHF has been in a downtrend.
However, there are signs that the downtrend might be coming to an end.
While the price has registered lower lows, the Stochastic (our indicator of choice) is showing a higher low.
Something smells fishy here.
Let’s think through what’s happening. Price pushed to a new low, but the Stochastic didn’t follow.
As we learned in the Regular Divergence lesson, this means the selling momentum behind that second drop was weaker than the first.
The bears are losing steam. That mismatch between price and the oscillator is our regular bullish divergence.
Is the downtrend coming to an end? Is it time to buy?
Now, a divergence alone wouldn’t be enough reason to jump in. But look more closely at that second low. Did you notice the tweezer bottoms that formed there?
That’s a bullish candlestick reversal pattern sitting right at the same spot where our divergence is flashing.
Two separate signals pointing in the same direction. That’s the kind of confirmation that makes a trader sit up and pay attention.
It turns out that the divergence between the Stochastic and price action was a good signal to buy.
Price broke through the falling trend line and formed a new uptrend.
If you had bought near the bottom, you could have made more than a thousand pips, as the pair continued to shoot even higher in the following months.
Now, can you see why it rocks to get in on the trend early?!
What Made This Setup Work
Let’s recap why this particular divergence was worth trading:
- Clear regular bullish divergence on the Stochastic (price made lower lows, oscillator made higher lows)
- Candlestick confirmation with tweezer bottoms at the second low
- Daily timeframe, which tends to produce more reliable divergence signals than lower timeframes
- A well-defined trend line that, once broken, gave additional confirmation that the reversal was real
This is what a solid divergence trade looks like. It’s not just “I see a divergence, time to buy.” It’s multiple pieces of evidence stacking up in the same direction.
How to Trade a Hidden Divergence
Next, let’s take a look at an example of some hidden divergence.
Once again, let’s hop onto the daily chart of USD/CHF.
Here we see that the pair has been in a downtrend.
Notice how the price has formed a lower high, but the Stochastic is printing higher highs.
According to our notes, this is a hidden bearish divergence!
Let’s break down what’s going on. The pair pulled back upward (a normal thing during a downtrend), and during that pullback, the Stochastic jumped higher.
If you only looked at the oscillator, you might think buying pressure was building.
But price tells the real story: It couldn’t even reach the previous high. The bears are still in control. The oscillator overreacted to the pullback, but the trend structure (lower highs) is still firmly intact.
Hmmm, what should we do? Time to get back in the trend?
Well, if you ain’t sure, you can always sit back and watch from the sidelines first.
If you decided to sit that one out, you might be as bald as Professor Xavier now because you pulled out all your hair.
Why?
Well, the trend continued!
Price bounced from the trend line and eventually dropped almost 2,000 pips!
Imagine if you had spotted the divergence and seen that as a potential signal for a continuation of the trend?
Not only would you be sipping those margaritas in the Caribbean, but you’d also have your own yacht to boot!
What Made This Setup Work
Let’s recap this one:
- Clear hidden bearish divergence on the Stochastic (price made a lower high, oscillator made a higher high)
- Existing downtrend was well-established, which is important because hidden divergence is a trend continuation signal, so you need a solid trend to continue
- Price respected the trend line, bouncing off it and resuming the downward move
- Daily timeframe again, giving the signal more weight
A Reality Check
These two examples are impressive, and they should be. They’re here to show you the potential of divergence trading when things go right.
But we’d be doing you a disservice if we didn’t mention that for every textbook divergence like these, there are setups that don’t play out so cleanly. Sometimes price will show a divergence and then just keep trending in the original direction.
Sometimes the reversal happens, but only for a small pullback before the original trend resumes.
That’s why the next few lessons in this series are so important.
We’ll cover how to avoid jumping in too early, the 9 rules for trading divergences, and why divergenceis should never be your only reason for entering a trade.
For now, the key takeaway is this: Divergences are powerful signals, but they work best when you combine them with other tools and exercise patience.
The traders who profit from divergences aren’t the ones who trade every single one. They’re the ones who wait for the setups where everything lines up.
What’s Next?
In the next lesson, we’ll show you some tips to help you avoid entering too early when you spot a divergence.
Because nothing’s worse than being right about the direction but wrong about the timing!