Hidden Divergences: Continuation Patterns


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Video Transcript:

Hello traders. Welcome to the sixth module of the technical analysis course, oscillators. In this lesson we are going to teach you all about hidden divergences. Like divergences, bearish and bullish divergences, the hidden divergences can also be spotted with any of the oscillators we have gone through on this module.

Let’s start. Like bearish and bullish divergences, hidden divergences occur when directional momentum signaled by an oscillator doesn’t confirm the price when we need the chart.

Unlike normal divergences, hidden divergences are a signal of trend continuation and not reversal. We are going to be looking for a divergence between the highs and the lows that the chart is showing and the highs and lows that the oscillator is making.

We are going to try and find setups to trend trade and not counter trend trade. A hidden bullish divergence occurs when price is making higher lows, but the oscillator makes lower lows. When this happens, you need to look for a spot to go long on an asset. When the security is making lower highs, but the oscillator is making higher highs, we are spotting for a hidden bearish divergence to go short on a continuation of the down move.

When a hidden divergence is spotted, you need to use your oscillator of choice’s entry rules and get confirmation from price actual like chart patterns and candlestick formations. If you are using trend lines, for example, you also need to look for maybe a candlestick formation that will show you that price has rejected the trend line and is in fact going to continue with the up move. Now, let’s go through some examples so you can better understand what we are talking about here.

Bullish Hidden Divergence

Now, here’s an example of a bullish hidden divergence. As you can see here we are in a clear up move and now price is making higher highs, but the oscillator is making lower highs. We have now spotted a bullish hidden divergence. We know that even though we have a ceiling here, which is this area of resistance, we are looking to go long on a breakout of this area because we have spotted a hidden bullish divergence which signals a trend continuation.

Many traders would want to go short here at the top in order to be short the asset before it breaks below this trend line, but this is the important thing about knowing how to use your oscillator. When you spot the hidden bullish divergence, you know that you are going to look for look for long opportunities, rather than short opportunities, because we have a signal that the trend may continue to the up side.

Of course this is not 100% guaranteed, but you already know something that most people don’t. You have an edge here. When the oscillator breaks with the 50 level, that should be enough of a signal to go long, but you need to understand that this resistance level has, in fact, been tested a lot of times, at least four times and it is a strong resistance level.

We have a lot of bearish pressure and short orders right here. We did a clean breakout, and a confirmation that this level has, in fact, been broken and that all of the bear pressure has been swept with.

Now, when the oscillator comes back and tests the 50 level of support and does not break it, and we have a break above resistance with the previous hidden bullish divergence, we have enough of a confirmation to go long here for a nice risk to reward ratio setup. Here’s an example of a hidden bearish divergence. As you can see, we are in a down move, and price is making lower highs.

Bearish Hidden Divergence

It’s easy to spot these hidden bearish and bullish divergences, because we are trying to spot them in a trending market. In a down trending market price is always making lower lows. The thing you have to look for is the oscillator making higher lows. When the oscillator is, in fact, making higher lows in a down move we have found a hidden divergence that signals a continuation of the move. When we take out the previous low on a small correction and the oscillator breaks with the 50 level, we have enough confirmation to go short and to take profit from this dip, well it’s not a dip, from this enormous move to the downside.

Now, most traders use hidden divergences as confirmation tools, and so can you. You can apply them to your trading rule if you were trying to get short on the U.S. dollar here and you don’t know where to go short on this small correction to the upside because, as you can see, we had a correction here and we had some bear pressure, but the correction was not over.

Here, it was the second case that bears appeared, but the correction was not over yet. Until it hit this previous area and of support and tested it as resistance we knew that we had a nice spot to go short, and it was confirmed with the hidden divergence on the RSI, the break below the 50 level, and the break of the previous low. All of this helps you get into positions that have a high probability of success. As trades, this is what we’re looking for, high probability of success.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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