Divergence trading - avoiding false signals

[Ceci N'est Pas Une Pip]

Hello Everyone,

I'm very interested in divergence trading and thought I was doing fine until the news yesterday. (Trading divergences on a daily chart).
First I wasn't waiting for the peak to form on my indicator so I got in way too early which killed me.

So I'm wondering, how do you filter the good divergences from the bad?

Thanks

[kagein]

post a screenshot of the trade you took

[Ceci N'est Pas Une Pip]

there, guess I should've waited til it got under 20 in stocks, all was fine and dandy til yesterday 9AM.

[GBLilleyUSMC]

In my experience, whenever you have stochastic or MACD divergence, price will go the way that the oscillator points, not the way price is pointing. Look on your own chart. On the swing low, where your divergence started. There was stoc divergence on the previous swing low that pointed long and price shot up.

I prefer MACD divergence on these settings (21, 55, 8) And I will not take divergence without some other kind of reason. I prefer to spot divergence on a 1 min chart after hitting support or resistance on the 15.

Here is a 2 hour AUDUSD chart that showed recent divergence. Note the way price reacted afterwards.

[kagein]

Originally Posted by Ceci N'est Pas Une Pip

there, guess I should've waited til it got under 20 in stocks, all was fine and dandy til yesterday 9AM.

divergence in its self would be enough for me to initiate a trade. I think you also have to look at price action as a confirmation. i.e is the trend over or will it continue. Strong reversal candles plus divergence will work well. That should filter most of you trades.

[tonymand]

Yes I agree with George. You had no reversal signal so the divergence is meaningless (remember it is simply showing you that momentum is slowing nothing more). That strong down candle followed by little in the way of retracement would suggest continuation not reversal. Price action is the key, indicators provide at best a little extra information which may call you to action. Remember that at news time in addition all bets are off. If the market is factoring in new prices as a result of changed information all indicators and even major SR levels become meaningless as the fundamentals take over at that point

[Ceci N'est Pas Une Pip]

The thing is when you wait for the candlestick confirmation you may miss most of the trend already. I'd rather be wrong and lose a little than be right but miss a lot.

Would a wide trailing stop minimize damage while maximizing potential you think?

[tonymand]

well its pros and cons. if you take a tight stop without confirmation you will expect less wins but a bigger payoff. you are quite right if you wait for too much confirmation it may be over. no right answer

[GBLilleyUSMC]

When divergence is factored into my trading, I will look for it at a key support or resistance level. You don't have to wait for a giant candlestick to use as confirmation. You can use several different things. Anything from a 1 min stochastic cross to a 15 min 5/8 cross. The question is how conservative are you? Also if you see multiple levels of support and resistance at one point there is nothing wrong with just simply taking a shot right at it with no confirmation (wouldn't do this on a daily chart, probrally 15 minute minimum). It works for me all the time; however, you must have flawless execution for this tactic because you are counting on price at least retracing enough for you to lock in a breakeven stop (risk free trade). Then if price hits your stop, oh well.

[BarryPips]

From the BabyPips School section on Divergences (hidden):

A hidden divergence is used as a possible sign for a trend continuation.

If price is making a higher low (HL), but the oscillator is making a lower low (LL), this is considered hidden bullish divergence.

Your chart shows a price with a higher low, and the indicator with a lower low. The above item from the School says that should be a continuation.

Now you have a dilemma: The divergence calls for a continuation of the trend, which was bearish on your chart. However they call it a "bullish divergence," which here might indicate a trend change (hence you went long).

Since you have contradictory information, it's probably best to stay out of the trade.

Just my pip and a half,
Barry

Edit: Looking back at the school page on hidden divergences, their graphic examples show trend changes not trend continuation, as the School mentions in the text.