When trading divergences, how to avoid entering too early

While divergences are an excellent tool to have in your trading toolbox, there are situations when you may enter too soon since you did not wait for more confirmation.

You'll keep getting stopped out if you keep entering too early (you do utilize stops, right？!) and you'll gradually lose money.

And you know what happens when even minor losses add up: you're bankrupt.

In terms of wealth, you'll wind up with a disconnect between your thinking and your wallet.

Here are a few (divergence) tricks of the trade that you can employ to increase your confidence that the divergence will work out in your favor.

Keep an eye out for an indicator crossover.

This is more of a guideline than a technique.

Simply wait for the momentum indicator to cross.

This could suggest a shift in momentum from purchasing to selling or the other way around.

The main reason for this is that you're waiting for top or bottom, which can't happen unless you make a crossing!

The pair made lower highs in the chart above, while the Stochastic had already hit higher highs. That's a bearish divergence right there, and it's tempting to short right now.

But, as the saying goes, patience is a virtue.

Wait for Stochastic to produce a downward crossover as proof that the pair is heading in the right direction.

The Stochastic did hit the crossing a couple of candles later.

What is the major point of this discussion？ Just take your time! You should not try to outrun the gun because you never know when momentum will alter!

If you don't have patience, you can get burned as one side continues to dominate!

Wait for the indicator to exit the overbought/oversold zone.

Another strategy is to wait for momentum highs and lows to reach overbought or oversold levels, then wait for the indicator to move out of these zones.

The reason for doing so is similar to the one for waiting for a crossover: you have no idea when momentum will start to shift.

Assume you're looking at a chart and see that the Stochastic has created a new bottom but the price hasn't.

Because the indicator is exhibiting oversold conditions and divergence has occurred, you might assume it's time to purchase.

However, the price may continue to decline and strike a new low as selling pressure remains strong.

You would have been disappointed if the trend had not continued.

In fact, the pair is now posting lower highs, indicating the start of a new downturn. You might have lost out on this down move if you were stubborn.

You may have avoided losing and understood that a divergence had formed if you had waited patiently for more confirmation.

On the momentum indicator, draw trend lines.

This may seem a little strange because trend lines are generally drawn only on price action.

But there's a neat little tip we'd like to share with you. After all, having another weapon in the holster can't hurt, right？ You'll never know when you'll need it!

This technique can be particularly beneficial when looking for trend reversals or breakdowns. When you notice that price is following a trend line, consider drawing a trend line on your indicator that is similar.

You'll see that the indicator follows the trend line as well.

If both price action and the momentum indicator break their respective trend lines, it may indicate a transfer in power from buyers to sellers (or vice versa) and a change in trend.