Spotting and reacting to "Divergence" can be very profitable!

Dave from http://www.informedtrades.com/ explaining how to go about identifying the "best" high-probability divergence trade setups. Please visit Dave's website for more tutorials and information. http://www.WhiteCloudMountain.com is a Managed Forex trading fund for Private Individual Investors. Please visit our site for more information on how White Cloud Mountain can help you with diversification, trading or investing in a managed account. Spotting and reacting to Divergence can be very profitable! Because trends are composed of a series of price swings, momentum plays a key role is assessing trend strength. As such, it is important to know when a trend is slowing down. Less momentum does not always lead to a reversal, but it does signal that something is changing, and that the trend may consolidate or reverse. Price momentum refers to the direction and magnitude of price. Comparing price swings helps traders gain insight into price momentum. Defining Price Momentum The magnitude of price momentum is measured by the length of short-term price swings. The beginning and end of each swing is established by structural price pivots, which form swing highs and lows. Strong momentum is exhibited by a steep slope and a long price swing. Weak momentum is seen with a shallow slope and short price swing. For example, the length of the upswings in an uptrend can be measured. Longer upswings suggest that the uptrend is showing increased momentum, or getting stronger. Shorter upswings signify weakening momentum and trend strength. Equal length upswings means the momentum remains the same. Price swings are not always easy to evaluate with the naked eye - price can be choppy. Momentum indicators are commonly used to smooth out the price action and give a clearer picture. They allow the trader to compare the indicator swings to price swings, rather than having to compare price to price. Common momentum indicators for measuring price movements include the relative strength index (RSI), stochastic and rate of change (ROC). An example of how RSI is used to measure momentum. The default setting for RSI is 14. RSI has fixed boundaries with values ranging from 0-100. For each upswing in price, there is a similar upswing in RSI. When price swings down, RSI also swings down. The study of momentum simply checks whether price and the indicator agree or disagree. Momentum Divergence Disagreement between the indicator and price is called divergence, and it can have significant implications for trade management. The amount of agreement/disagreement is relative, so there can be several different patterns that develop in the relationship between price and the indicator. For this tutorial, the discussion will be limited to the basic forms of divergence. It is important to note that there must be price swings of sufficient strength to make momentum analysis valid. Therefore, momentum is useful in active trends, but it is not useful in range conditions in which price swings are limited and variable. Divergence in an uptrend occurs when price makes a higher high, but the indicator does not make a higher high. In a downtrend, divergence occurs when price makes a lower low, but the indicator does not make a lower low. When divergence is spotted, there is a higher probability of a price retracement. Divergence helps the trader recognize and react appropriately to a change in price action. It tells us something is changing and that the trader must make a decision about the trade, such as tighten the stop-loss or take profit. Seeing divergence increases profitability by alerting the trader to protect profits. Managing Divergence Divergence indicates that something is changing, but it does not mean the trend will reverse. It signals that the trader must consider strategy options: holding, selling, tightening the stop or taking partial profits. The glamour of wanting to pick the top or bottom is more about ego than profits. To be consistently profitable is to pick the right strategy for what price is doing, not what we think price will do. The most useful way to use a momentum indicator is to know what strategy to use. Price will lead the way but momentum can indicate a time to preserve profits. The skill of a professional trader lies in his or her ability to implement the correct strategy for price action. White Cloud Mountain is a Managed Forex Trading Fund for Traders and Private Investors: http://www.WhiteCloudMountain.com .

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