The Best “HIDDEN DIVERGENCE” Trend Following Strategy (Forex & Stock Trading System)

If you’re a trend trader and prefer the swing trading , I’m sure that you face the same problems I was facing. when I started trading, the main struggle as traders is to exactly pinpoint the market entry in order to catch the next big move .

But what if you developed a simple swing trading setup that would generate high probability entry signals?…

I will share with you a SIMPLE and an EASY swing trading strategy that will improve your trading results.

The core of this system relies on divergences between the price and the stochastic indicator in the direction of the prevailing trend on the market indicated by the 200 EMA.

Let’s dive right into this strategy and see how it works.

 

Here’s THE FIRST RULE of the strategy.

• We need to spot divergences between the price action and the stochastic indicator.

If you are a trend trader divergences should be one of your most important tools because the divergence signals momentum coming into the main trend suggesting a possible continuation in the prevailing direction of the market as you probably know.

There are two types of divergences, a REGULAR and HIDDEN.

A REGULAR DIVERGENCE involves higher high prices and lower indicator values during an uptrend and lower low prices and higher indicator values during a downtrend.

When this happens, that’s an indication of;

• market exhaustion
• a possible sign of market reversal or…
• at least a short-term correction.

A HIDDEN DIVERGENCE is a visual non-confirmation which involves higher lows of the price but lower indicator values during an uptrend and lower highs of the price but higher indicator values during a downtrend.

A hidden divergence signals a continuation move in the direction of the prevailing trend.

That’s why if you prefer to take positions in the direction of the main trend the hidden divergence can generate some pretty accurate signals.

For spotting divergences you can use many tools but I prefer to use the stochastic indicator.

Now here’s the key to our system.

WE DON’T TRADE ALL THE DIVERGENCES.

During strong trends the stochastic will generate divergence after divergence and most of the signals will probably fail.

You look at this GBPUSD chart and as you can see the price was in a strong downtrend and the stochastic indicator generated several divergences but most of these signals were false.

That’s a wrong approach in what concerns trading the divergences.

We have to be smart and filter this technique in order to eliminate false signals now here’s the second rule of this strategy.

Here’s  THE SECOND RULE of the strategy.

• Will establish the main trend with a 200 period exponential moving average, and we only trade divergences in the direction of the main trend.

Also I only trade on the hourly on the 4 hours and on a daily timeframes in order to reduce the market noise and filter the bad signals generated on shorter timeframes.

Here’s how it takes signals with this swing trading setup.

1. When the price trades above the 200 EMA, we consider taking ONLY LONNG entries.
2. When the price trades below the 200 EMA we consider taking ONLY SHORT entries.

We search for divergences between the stochastic indicator and the price only in the direction of the main trend indicated by the 200 EMA.

If the price trades above the 200 EMA we search for divergences on the lower side of the stochastic and if the price trades below the 200 EMA we search for divergences on the upper side of the stochastic.

A very important, we are not interested in trading divergences that signal reversals possible pull backs or counter trend positions.

 

Here’s the GBPUSD on the four hours time frame.

We determine the upward trend with the 200 EMA and we start searching for divergences on the lower side of the indicator and we only consider to go along on the market the first signal was the buy entry after a hidden divergence around 200 EMA observe how the price was making higher lows but the indicator was making lower lows.

If we look at the chart we see THE PRICE MAKING LOWER LOWS but THE STOCHASTIC MAKING HIGHER LOWS.

The fifth signal was a hidden divergence observe how the price was making higher lows but the indicator was making lower lows.

As you can see we ignored all the signals offered by the divergences on the upper side of the stochastic.

As we are in a strong upward trend let’s look at this NZDUSD chart also.

On the four hours timeframe we establish the downward trend with a 200 EMA and we start searching for divergences on the upper side of the indicator this time.

See how the price is making higher highs but the indicator is making lower highs.

As you can see we ignored all the signals offered by the divergences on the lower side of the stochastic.

As we’re in a strong downward trend the trick of the strategy is to determine the main trend with the 200 EMA and only take positions in the direction of the trend

So we don’t chase all the divergences that occur on the chart. We only trade the ones with a higher probability meaning the ones in the direction of the main trend.

If you are a trend-following trader you should train your eyes to spot the divergences on different charts, please keep in mind that this system is more reliable when you are using higher timeframes.

A signal that is produced on the 4-hour or on the daily chart is more reliable than a signal produced on the 15-minute chart, but divergence is more reliable on higher time frames because the market does not move as fast and is easier to define trends by using higher time frames.
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