DIVERGENCE is one of my favs, next to the LRC of course, but one must keep in mind that divergence is a “prophetic” indicator – it is indicating “future” movement, BUT not always WHEN that movement happens !
the way i use it is to watch as it forms in whatever trade i might be in. Let us say im LONG and have set my tp point based on resistance points.
when the price is hit, invariably on ANY timeframe, there will be a retrace BUT the DIVERGENCE that i have seen forming tells me two things. FIRST, the retrace should not be a SMALL one (say to ONLY the 23% fib) and it tells me that the price will NOT continue UP.
PRE-ARMED with this information, i can then decide on WHATEVER strategy i wish to employ here, which would normally be to sell the LONG position and wait for the confirmation of the downside move and enter SHORT, as was stated by Ken.
The ONLY difference is that i will wait for a definite confirmation of the reversal by placing a tp at the 23 fib AND THEN WATCHING to see if the SHORT continues (you can also place a “sell stop” below the 23 fib to be hit automatically when the price continues down but will NOT be hit (hopefully) if the price now reverses and goes LONG again.
[B]the reason for using the 23 fib (or any support in that area) is that almost all retraces will move to that point, while “SOME” will definitely continue down — taking profit at the 23 assures you of not getting caught if the market SUDDENLY decides to do a unplanned and unthought of reversal back to the upside. And once you can see that the move will continue down, as they “most” often do, then you reenter the trade and prepare for a good ride ![/B]
BE VERY CAREFUL with divergence in a very active market, because divergence is definitely telling you a good story, BUT it doesnt always tell you when that story will be read !
Given your basic “average” situation, DIVERGENCE is a powerful tool indeed and the reason why i designed a small indicator that handles that “prophetic” nature and includes a couple of ma x-overs to help get one kick started in the proper direction.
anyway, Ken is correct in the value of this tool but one must also be careful of when and where it is used, especially lately.
enjoy and trade well
[I][B][I]Within the great hall at Elfinore stands a wondrous coffer, precisely four cubits square and securely latched against the outside world. Inside that repository, shut away from impertinent eyes, abides many an intriquing trading secret garnered from around the world and over the ages !
As a child, i used to watch from the darkness as the secrets were debated and annotated by the elders. No one there held a single thought of my presence – BUT I KNOW WHERE THEY HID THE KEY !!