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Put very simply, my understanding of “divergence” in forex trading is that a momentum indicator such as CCI can show what is called “divergence” in that the momentum or strength in the direction of the trend has weakened despite that the price has made a new high or low. That is a long sentence but it does explain divergence.
If you want to look out for divergence, I look for it on a 4 hourly chart but also on other charts, too. What you will generally see is the price hitting a low, forming a bit of a base or retracing somewhat then reverting back in the direction of the original trend.
At the same time you are able to see on your MACD and/or CCI indicators that the momentum has not increased in that direction. It has decreased. This indicates a reversal and an opportunity to trade for once, against the trend. A recent example was making a lot of pips on GBP/USD.
Instead of “guessing” when the GBP/USD was going to form a temporary bottom and getting stopped out, patiently waiting for the MACD on the four hourly chart to show clear DIVERGENCE could have allowed the catching of the correction from 1.9600 to 1.9800 before the retrace.
See the chart below to illustrate this example (coming soon)…
Description of diagram.
The blue arrows represent a temporary bottom that has formed on the chart, the MACD (blue line) and the CCI (turns up).
The red arrows show a lower bottom (price is lower) but the CCI bottom is higher and the MACD blue line is higher. This is contrary to the trend and the price action and is known as divergence.
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