Divergences + Oscillator Confirmation: A Simple System.
This will be a tutorial using divergences and oscillator confirmation buy/sell signals.
Hello. Here I present a simple system that is very profitable but along side this system I will present a risk management system that is
easy on emotions and robust on capital.
I predominantly use the 1hr and the 4hr to look for both REGULAR divergences and HIDDEN divergences. The reason I use the 1hr and 4hr is because I
find them easiest to trade. We can spot great and powerful divergences in the weekly or daily time frame but how do you enter into positions on such large time frames? We can't unless we use huge stops and tiny sizes. Therefore we can look for better opportunities in the 1hr and 4hr timeframes where those divergences are reliable and risk is easier to manage. I do not recommend moving any lower than the 1hr time frame because oscillators just generate noise
and bad trades.
REGULAR DIVERGENCE is perhaps easier to identify but more difficult to trade because they most often happen at trend changes when volatility tends to rise. I associate less risk with REGULAR DIVERGENCE specifically smaller positions and wider stops because tops or bottoms are difficult to time.
If you are an inexperienced trader it is best for you to start looking at hidden divergences which trade with the trend.
HIDDEN DIVERGENCE is easiest to trade but possibly more difficult to identify. HIDDEN DIVERGENCE tends to be a continuation of the trend confirmation. This for me tends to be easier to trade because you are buying a dip in the trend which tends to be less volatile (of course this is not always the case and you can see for yourself if you start trading divergences)
REGULAR BULLISH DIVERGENCE:
Regular bullish divergence is when the price action makes a lower low while an oscillator like
The RSI or the Stochastic makes a higher low.
REGULAR BEARISH DIVERGENCE
Regular bearish divergence is when the price action makes a higher high but the
oscillator makes a lower high
HIDDEN BULLISH DIVERGENCE
Hidden bullish divergence is when price action makes a higher low and the oscillator makes a lower low.
HIDDEN BEARISH DIVERGENCE
Hidden bearish divergence is when price action makes a lower high while the oscillator makes a
Higher high.
The method I use is simple.
STEP ONE: IDENTIFY THE TREND: I use the 200EMA in the 1hr or 4hr time frame and take trades corresponding with the trend. The 200EMA simply acts as a method to gauge if the price action is bullish or bearish. If the price action is above the 4hr EMA then I look for a bullish set up. If the price action is below the 4hr 200EMA then I look for a bearish set up. ( I must admit I do not always follow my advice here as today I went short and long but with experience comes flexibility). If you are an unprofitable trader I highly recommend sticking to this part of the system to prevent overtrading and take the most probable trades possible.
STEP TWO: IDENTIFY REGULAR OR HIDDEN DIVERGENCE. This step will get easier with practice. As you see in this chart,
We see both REGULAR DIVERGENCE which IMO is easier to spot and we have also HIDDEN DIVERGENCE which is more difficult to spot as it is across days.
So now that we have identified divergences in the Stochastic RSI we are looking for a confirmation of the divergences we just found.
The Stochastic RSI is simple to use when used with divergences. With out divergences the Stochastic RSI gives too many signals and sometimes wrong signals therefore we should only use the Stochastic RSI (or your oscillator of choice) when combined with divergences. If it is a perfect set up such as the morning trade where I found regular negative divergence I waited for the 1hr Stochastic RSI oscillator to confirm a sell signal by crossing the 70% line DOWNWARDS. I set the correct stop of 1% (more on risk management later) and waited for the oscillator to turn down to oversold where amazingly enough
it fell and created HIDDEN BULLISH DIVERGENCE when we plotted a line from previous days' Stochastic history. Once the Stochastic turned upward on the 20% line this was my signal to exit the trade...AND because the Stochastic had now created HIDDEN BULLISH DIVERGENCE I took the long side which
was an even better trade. Days like today do not happen often if ever but if you read my previous posts I had been anticipating such scenarios based on other factors I will not go into here. Read them posts if you want to know how I suspected this kind of price action was going to happen.
STEP THREE: Is not a step, like I mentioned this is an incredibly simple system but no system is complete without robust RISK MANAGEMENT.
The risk management comes from the great traders at Guerrilla Trading. I am not affiliated in any way but I was with them for two months and
I highly highly recommend them. You will learn price action like no one else. Here I borrow on their money management ideas (I will not share all their ideas
that would be unfair to them). It is simple. We will use only 1% risk by setting our stops accordingly. In the trade short in the morning on the micro Nasdaq I took a stop of 80 points. But I calculated my size according to my total capital meaning that if the Nasdaq moved against me 80 points I would only lose 1% of total capital. That's great! If the trade goes against me I would have only lost 1%. But as I have flexible stops, I also have no fixed targets and I let the oscillator let me know when to get out. In the case of the morning trade I took around 206 points. I did not know where the exit would be I just knew the oscillator would tell me. But as you can see by risking a psychologically manageable amount of risk I was comfortable in leaving the trade on until the oscillator told me when to exit.
Similarly on the lunch trade where I found HIDDEN BULLISH DIVERGENCE and the Stochastic RSI confirmation crossing the 20% line I took the trade
and I am still in the trade because neither the 1hr Stochastic RSI oscillator nor the 4hr oscillator have signalled a sell signal yet. And this is my
own personal strengthening of the system. I try to take the 1hr trade over to the 4hr trade where I find I can remove as much of the noise from the lower timeframes as possible and capture almost an entire move. Shwing Trading baby!
Well that is it. A simple system using divergences and oscillators to create great trading opportunities. This coupled with a 1% risk management and we
have a powerful system that protects capital and maximizes rewards.
Included here are several different examples of divergences I have posted on different time frames to get you started on your journey of using divergences.
Hello. Here I present a simple system that is very profitable but along side this system I will present a risk management system that is
easy on emotions and robust on capital.
I predominantly use the 1hr and the 4hr to look for both REGULAR divergences and HIDDEN divergences. The reason I use the 1hr and 4hr is because I
find them easiest to trade. We can spot great and powerful divergences in the weekly or daily time frame but how do you enter into positions on such large time frames? We can't unless we use huge stops and tiny sizes. Therefore we can look for better opportunities in the 1hr and 4hr timeframes where those divergences are reliable and risk is easier to manage. I do not recommend moving any lower than the 1hr time frame because oscillators just generate noise
and bad trades.
REGULAR DIVERGENCE is perhaps easier to identify but more difficult to trade because they most often happen at trend changes when volatility tends to rise. I associate less risk with REGULAR DIVERGENCE specifically smaller positions and wider stops because tops or bottoms are difficult to time.
If you are an inexperienced trader it is best for you to start looking at hidden divergences which trade with the trend.
HIDDEN DIVERGENCE is easiest to trade but possibly more difficult to identify. HIDDEN DIVERGENCE tends to be a continuation of the trend confirmation. This for me tends to be easier to trade because you are buying a dip in the trend which tends to be less volatile (of course this is not always the case and you can see for yourself if you start trading divergences)
REGULAR BULLISH DIVERGENCE:
Regular bullish divergence is when the price action makes a lower low while an oscillator like
The RSI or the Stochastic makes a higher low.
REGULAR BEARISH DIVERGENCE
Regular bearish divergence is when the price action makes a higher high but the
oscillator makes a lower high
HIDDEN BULLISH DIVERGENCE
Hidden bullish divergence is when price action makes a higher low and the oscillator makes a lower low.
HIDDEN BEARISH DIVERGENCE
Hidden bearish divergence is when price action makes a lower high while the oscillator makes a
Higher high.
The method I use is simple.
STEP ONE: IDENTIFY THE TREND: I use the 200EMA in the 1hr or 4hr time frame and take trades corresponding with the trend. The 200EMA simply acts as a method to gauge if the price action is bullish or bearish. If the price action is above the 4hr EMA then I look for a bullish set up. If the price action is below the 4hr 200EMA then I look for a bearish set up. ( I must admit I do not always follow my advice here as today I went short and long but with experience comes flexibility). If you are an unprofitable trader I highly recommend sticking to this part of the system to prevent overtrading and take the most probable trades possible.
STEP TWO: IDENTIFY REGULAR OR HIDDEN DIVERGENCE. This step will get easier with practice. As you see in this chart,
So now that we have identified divergences in the Stochastic RSI we are looking for a confirmation of the divergences we just found.
The Stochastic RSI is simple to use when used with divergences. With out divergences the Stochastic RSI gives too many signals and sometimes wrong signals therefore we should only use the Stochastic RSI (or your oscillator of choice) when combined with divergences. If it is a perfect set up such as the morning trade where I found regular negative divergence I waited for the 1hr Stochastic RSI oscillator to confirm a sell signal by crossing the 70% line DOWNWARDS. I set the correct stop of 1% (more on risk management later) and waited for the oscillator to turn down to oversold where amazingly enough
it fell and created HIDDEN BULLISH DIVERGENCE when we plotted a line from previous days' Stochastic history. Once the Stochastic turned upward on the 20% line this was my signal to exit the trade...AND because the Stochastic had now created HIDDEN BULLISH DIVERGENCE I took the long side which
was an even better trade. Days like today do not happen often if ever but if you read my previous posts I had been anticipating such scenarios based on other factors I will not go into here. Read them posts if you want to know how I suspected this kind of price action was going to happen.
STEP THREE: Is not a step, like I mentioned this is an incredibly simple system but no system is complete without robust RISK MANAGEMENT.
The risk management comes from the great traders at Guerrilla Trading. I am not affiliated in any way but I was with them for two months and
I highly highly recommend them. You will learn price action like no one else. Here I borrow on their money management ideas (I will not share all their ideas
that would be unfair to them). It is simple. We will use only 1% risk by setting our stops accordingly. In the trade short in the morning on the micro Nasdaq I took a stop of 80 points. But I calculated my size according to my total capital meaning that if the Nasdaq moved against me 80 points I would only lose 1% of total capital. That's great! If the trade goes against me I would have only lost 1%. But as I have flexible stops, I also have no fixed targets and I let the oscillator let me know when to get out. In the case of the morning trade I took around 206 points. I did not know where the exit would be I just knew the oscillator would tell me. But as you can see by risking a psychologically manageable amount of risk I was comfortable in leaving the trade on until the oscillator told me when to exit.
Similarly on the lunch trade where I found HIDDEN BULLISH DIVERGENCE and the Stochastic RSI confirmation crossing the 20% line I took the trade
and I am still in the trade because neither the 1hr Stochastic RSI oscillator nor the 4hr oscillator have signalled a sell signal yet. And this is my
own personal strengthening of the system. I try to take the 1hr trade over to the 4hr trade where I find I can remove as much of the noise from the lower timeframes as possible and capture almost an entire move. Shwing Trading baby!
Well that is it. A simple system using divergences and oscillators to create great trading opportunities. This coupled with a 1% risk management and we
have a powerful system that protects capital and maximizes rewards.
Included here are several different examples of divergences I have posted on different time frames to get you started on your journey of using divergences.
Comment:
RISK MANAGEMENT: I forgot to mention something very important. This is the idea of SCALING UP IF WE WIN and SCALING DOWN IF WE LOSE. We always want to keep 1% risk total. Therefore if we have capital of $10,000 and we take a trade we will risk only $100. If we win say 3% we made $300. Great! Now on the next trade we no longer will risk $100, we will risk 1% of $10300, which is $103.
Great! But if we took that trade and lost $100 or our 1% total risk we now have $9900 total capital. Therefore on our next trade we will not risk $100 but $99. This is a crucial aspect of the management of risk. WE MUST SCALE UP if we win
just as WE MUST SCALE DOWN if we lose. This simple modulation of risk has shown to help manage risk that much better.
Great! But if we took that trade and lost $100 or our 1% total risk we now have $9900 total capital. Therefore on our next trade we will not risk $100 but $99. This is a crucial aspect of the management of risk. WE MUST SCALE UP if we win
just as WE MUST SCALE DOWN if we lose. This simple modulation of risk has shown to help manage risk that much better.
Sorry about that.