While using divergences is a great tool to have in your trading toolbox, there are times when you might enter too early because you didn’t wait for more confirmation.
If you keep entering too early, you’ll keep getting stopped out (you do use stops, right?!) and you’ll slowly rack up losses.
And you know what happens when even small losses accumulate? You end up broke.
You’ll end up with a divergence between your mind and your wallet regarding your wealth.
Nobody wants that. So let’s fix it.
Below are three techniques you can use to confirm that a divergence is actually playing out before you commit your hard-earned money. Think of these as your “patience filters.”
Each one helps you wait just long enough for momentum to actually shift before you pull the trigger.
Trick #1: Wait for an Indicator Crossover
This ain’t so much a trick as it is a rule. Just wait for a crossover of the momentum indicator.
A crossover indicates a potential shift in momentum from buying to selling, or vice versa. The main reasoning behind this is that you are waiting for a top or bottom to form, and those can’t form unless a crossover is made!
In the chart above, the pair showed lower highs while the Stochastic already made higher highs. Now that’s a bearish divergence, and it sure is tempting to short right away.
But you know what they say, patience is a virtue.
Here’s the problem with jumping in the moment you spot the divergence: you’re betting that momentum has already shifted, but the indicator hasn’t confirmed it YET.
The Stochastic is still pointing upward. That’s like seeing dark clouds and assuming it’s raining before you’ve felt a single drop.
Maybe it will rain. Or maybe the wind blows those clouds right past you.
It’d be better to wait for the Stochastic to make a downward crossover as confirmation that the pair is indeed headed down.
A couple of candles later, the Stochastic did make that crossover. Playing that bearish divergence would’ve been piptastic!
What’s the main point here? Just be patient! Don’t try to jump the gun because you don’t quite know when momentum will shift!
If you aren’t patient, you might just get burned as one side keeps dominating!
How This Works With Different Indicators
The crossover approach works slightly differently depending on which oscillator you’re using:
- Stochastic: Wait for the %K line to cross below the %D line (bearish) or above it (bullish). This is the most classic crossover signal.
- MACD: Wait for the MACD line to cross below the signal line (bearish) or above it (bullish). You can also watch for the histogram to flip from positive to negative or vice versa.
- RSI: RSI doesn’t have a built-in crossover like Stochastic or MACD. Instead, watch for RSI to break below 70 (after a bearish divergence) or above 30 (after a bullish divergence). This ties into our next trick.
Trick #2: Wait for the Indicator to Move Out of Overbought/Oversold Territory
Another technique is to wait for momentum highs and lows to hit overbought and oversold conditions, and then wait for the indicator to move out of these conditions.
The reasoning is similar to waiting for a crossover. You really don’t have any idea exactly when momentum will begin to shift. A divergence tells you it might shift, but it doesn’t tell you when.
Let’s say you’re looking at a chart and you notice that the Stochastic has formed a new low while the price hasn’t. You may think that it’s time to buy because the indicator is showing oversold conditions and a divergence has formed.
However, selling pressure may remain strong, and the price continues to fall and make a new low.
You would have been pretty bummed out as the trend didn’t continue in the direction you expected.
In fact, a new downtrend is probably in place as the pair is now forming lower highs. And if you were stubborn and held on, you might have missed out on this down move also.
This is a really important point, so let’s spell it out: an indicator can stay in overbought or oversold territory for much longer than you think.
Just because the Stochastic is below 20 doesn’t mean it has to bounce immediately. In strong trends, oscillators can get “pinned” at extreme levels for extended periods while the price keeps moving against you.
The safer approach? Wait for the indicator to actually exit overbought or oversold territory.
When the Stochastic climbs back above 20 after being oversold, or drops back below 80 after being overbought, that’s your signal that the momentum shift is actually happening, not just threatening to happen.
If you had waited patiently for more confirmation that the divergence was playing out, then you could have avoided losing and realized that a new trend was developing.
Trick #3: Draw Trend Lines on the Momentum Indicator Itself
This might sound a little ridiculous since you would normally draw trend lines only on price action.
But this is a nifty lil’ trick that we wanna share with you. After all, it doesn’t hurt to have another weapon in the holster, right? You never know when you might use it!
Here’s the idea. When you see that the price is respecting a trend line, try drawing a similar trend line on your indicator. You may notice that the indicator respects its own trend line also.
This trick can be particularly useful when looking for reversals or breaks from a trend.
If you see both price action and the momentum indicator break their respective trend lines, it could signal a shift in power from buyers to sellers (or vice versa) and that the trend could be changing.
Why does this work? Because trend lines on the oscillator are essentially tracking the trend of momentum itself.
When the price breaks its trend line, that tells you the price structure has changed. When the oscillator breaks its trend line at the same time, it tells you the momentum structure has also changed.
Both breaking together is a much stronger signal than either one alone.
Putting It All Together
You don’t have to use all three techniques on every trade. The key principle behind all of them is the same: don’t chase the divergence. Let it come to you.
Here’s a simple way to think about it:
- Crossovers are your go-to confirmation for Stochastic and MACD setups
- Overbought/oversold exits work well with RSI and Stochastic
- Indicator trend lines are a bonus tool for when you want extra confirmation on a reversal
Consistent divergence traders aren’t the ones who spot the most setups. They’re the ones who have the discipline to wait for confirmation before entering.
A slightly worse entry price with solid confirmation behind it will beat a “perfect” early entry that gets stopped out nine times out of ten.
What’s Next?
Now that you know how to avoid jumping in too early, it’s time to learn the complete set of rules for trading divergences.
In the next lesson, we’ll give you all 9 of them.
Learn ’em, memorize ’em, live ’em!