How can divergence be used to identify reversal points? Techniques used by professionals

Trading forex involves identifying trend reversal points, which traders highly anticipate. Once a reversal point is detected, it creates favorable conditions for trading, such as selling at the highest price in a cycle or buying at the lowest. However, attempting to estimate reversal points based solely on news or visual guesses carries significant risks. Therefore, many professional traders turn to technical tools to confirm price reversals, especially by observing divergence signals between indicators and price, which can improve trading accuracy.

Why Use Divergence to Find Reversal Points

When using indicators to identify reversals, relying only on Overbought or Oversold levels can lead to errors. During strong market trends, indicators can remain overbought or oversold for extended periods, resulting in multiple false signals. Traders have developed a new approach by observing divergence, which occurs when the price moves in one direction while the momentum indicated by an indicator moves in the opposite direction. Detecting this signal helps traders identify potential reversals more effectively.

Reliable Reversal Indicators for Forex Trading

( OBV Divergence (On Balance Volume)

OBV is an indicator that measures trading volume relative to price changes. When OBV trends upward sharply, it indicates strong accumulation, while a declining OBV suggests gradual selling.

Bearish Divergence occurs when the forex price makes new highs repeatedly, but OBV shows a declining trend. This indicates that although prices are rising, buying volume is decreasing, and selling is gradually increasing—warning signs that the upward move lacks strong fundamentals and may reverse downward.

Bullish Divergence occurs when the forex price makes new lows repeatedly, but OBV shows an increasing trend. This suggests that while prices are falling, buying volume is gaining strength, indicating that large investors are preparing for a price increase.

) MACD Divergence (Moving Average Convergence Divergence)

MACD is a versatile indicator that reflects both momentum and trend. To find MACD divergence, focus on the Histogram, which represents the difference between the MACD Line and the Signal Line.

Bearish Divergence appears when the forex price reaches new highs and continues to rise, with the Histogram also increasing. However, the Histogram’s value at the new high is lower than at the previous high, indicating weakening upward momentum and a potential trend reversal.

Bullish Divergence appears when the forex price makes new lows, with the Histogram decreasing further (becoming more negative). Yet, if the Histogram at the new low is not as low as the previous one, it suggests that the downward momentum is waning, and a reversal upward may be imminent.

RSI Divergence (Relative Strength Index)

RSI is widely used in forex trading because of its simplicity, with values ranging from 0 to 100. Traders often watch the 70 and 30 levels.

Bearish Divergence occurs when the forex price makes new highs, often higher than previous highs, while RSI enters the overbought zone above 70. If the price reaches a new high but RSI does not, it indicates weakening buying pressure and a possible upcoming decline.

Bullish Divergence occurs when the price makes new lows, but RSI enters the oversold zone below 30. If the price drops to a new low but RSI does not, it suggests that selling pressure is diminishing, and a price rebound could occur soon.

Key Points for Using Divergence in Forex Trading

To effectively use divergence for identifying reversals, traders should go beyond just observing indicator signals. It’s important to analyze price structure as well. For example, bearish divergence is more significant when the price is making strong upward moves and appears overbought from the top, while bullish divergence is more reliable when it occurs near strong support levels.

Experienced traders do not rely solely on divergence signals to enter trades. Instead, they seek additional confirmations, such as reversal chart patterns or trendline touches. Combining these signals increases confidence and improves the likelihood of successful trades, making divergence a valuable tool in forex trading.