Forex Course

132. Rules Of Trading Divergence


Divergence is used by traders to determine if there is going to be a reversal or a trend continuation. They sometimes work exceptionally well and, at times, goes entirely in the anticipated direction. Thus, to increase the consistency of divergence, we have listed out some rules for trading divergence.

#1 Focus only on four price patterns

For legitimate divergence to exists, their price pattern must be either of the following:

If spot a divergence on the indicator that does not have either of the above price action, then the divergence will not work.

Several times, the price consolidates and shows divergence on the indicator. But there will not be any proper top or bottom to confirm that the divergence is real. Thus, such divergence must be ignored.

#2 Connect the lines only for significant highs and lows

Now that you know, we are concerned with one of the four patterns โ€“ higher high, lower low, equal high, and equal low.ย When it comes to drawing the trend lines, you must make sure the highs and lows are major enough to be considered. A little bump up or dips that may look like a higher high or lower low must be ignored.

#3 Mark the corresponding highs and low

Always start by drawing the highs and lows from the price charts. Then you mark the highs and lows on the indicator corresponding with the highs and lows with the price.

Pro tip: Draw two vertical lines to perfectly mark the corresponding highs and lows.

#4 Compare the length and strength of the pushes

This is one of the most important points to consider. In a trending market, the price makes higher highs or lower lows. But, when there is a divergence for a particular push, you must make sure that the momentum is weaker, and length is smaller than the previous trend sequence.

In the above chart, we can clearly ascertain that the lower low, which had divergence was much weaker and shorter than the previous push. As a result, the market reversed and had a big bull run.

#5 Do not try catching a falling knife

There are times when the market does not consolidate before reversing its direction. There could not be any entry for such trades. But there are traders who chase the market and end up buying at very high prices, which could be bad for business. Thus, you be patient and wait for the right opportunity, because buying at higher prices, could hinder the risk to reward ratio, leading to a high risk for small profits.

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Forex Course

110 – The Key Rules in the Elliot Wave Theory


The Elliot Wave theory is a subjective topic. The key to trading Elliot waves is to find and comprehend the waves correctly. By understanding the wave theory correctly, we will be able to figure out which side of the market we have to be on. For doing so, there are a few rules we can lay on the Elliot waves while confirming the legitimacy of a wave. They are based on waves in the 5-3 wave pattern. And most importantly, these rules must never be broken.

The Three Golden Rules of Elliot Wave Theory

Rule 1: Wave 2 must be above wave 1

Wave 1 is the impulse wave, which is towards the trend, while wave 2 is a smaller corrective wave against the trend. So, to hold the definition of an uptrend, the second wave must never go below the first wave. In other terms, there should be a higher low in the price.

Rule 2: Wave 3 must never be the shortest impulse wave

Wave 3 is the second push towards the overall trend. This wave represents the move where all big players buy into the market. Hence, this wave is the strongest and the longest. According to the rule, the wave 3 can be shorter than either wave 1 or wave 5, but not BOTH.

Rule 3: The Wave 4 must stay above the wave 1

Wave 4 is the second corrective wave in the 5-wave pattern. And this wave should never cross below the area of wave 1. In technical terms, the low of Wave 4 must be higher than the high of Wave 1.

This sums up the rules that need to be mandatorily followed while trading the Elliot Waves. So, even if one of the rules is not satisfied, then the Elliot wave pattern must be counted from the beginning, and the current must be discarded.

Guidelines for trading Elliot Waves

Now that you are clear about the rules, here are some guidelines for trading the Elliot waves. Note that these are guidelines and not rules. Hence, they are not a necessary condition to trade Elliot waves.

๐ŸŒŠ When Wave 5 is the longer impulse wave, then wave 5 can approximately be as lengthy wave 1.

๐ŸŒŠ It is useful in targeting the end of Wave 5. Traders also determine the length of the Wave 1 and add it with the low of Wave 4 and use it as a possible target.

๐ŸŒŠ Wave 2 and Wave 4 will usually be different forms. For instance, if Wave 2 was a sharp correction, then Wave 4 will be a flat correction and vice versa. With this, chartists can determine the time of correction of Wave 4

๐ŸŒŠย After a strong Wave 5 impulse wave advance, the 3-wave ABC correction pattern could come down only until the low of Wave 4.

These are the guidelines traders must understand and interpret in their own meaningful way. With this, we have come to the stage where we can apply the concepts and trade the Forex market. So, stay tuned for the next lesson.

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