Price movement in the Forex market is never static. It changes every day, as there are lots of external factors influencing it. Because of this swing, experts have developed the momentum theory to predict the direction of the market, determine the buy or sell point of the chart, and so on. The momentum theory also helps a trader identify the strength of the trend. The momentum divergence concept can show an investor the direction of a trend more accurately.
What is price momentum?
Before we proceed, we better define the price momentum, which is calculated by the length of a short-term swing of the price. The momentum will be stronger when there is a steeper slope, and the price experiences a huge swing. It also evaluates whether the real trend or slope agrees with the indicator or not.
Momentum divergence appears when there isa disagreement between the actual trend and the indicator. It can help you with trade management, as it has several implications. You may come across various patterns of the relationships between the indicator and the real trend. Remember that this theory is applicable to the trending market. Using it in a ranging market will not produce an effective result. Being a rookie trader in the Hong Kong trading community, you can also use Saxo capital markets demo account. With the help of a demo platform, you can learn its core function with zero risk.
Since momentum divergence deals with disagreement between the actual trend and the indicator, you will see it when the real market is showing a clear uptrend, but the indicator doesn’t, or vice versa. When a trader sees it, he has to be careful because there is a greater possibility of a price retracement. Divergence will help a FX investor realize and react in the appropriate way to achange in the price action. You will understand that something is changing in the market, and you have to make a decision quickly (such as setting a tight stop-loss or take-profit order).
In the market, there are four types of divergence –
- Bullish divergence: When the actual market is experiencing a bearish movement, but the indicator exhibits an upward trend, it is called a bullish divergence.
- Bearish divergence: When the existing market is experiencing a bullish movement, but the indicator shows a downward trend, it is called a bearish divergence.
- Bullish hidden divergence: Bullish hidden divergence takes place when the real market trend makes a higher low, but the indicator makes a lower low.
- Bearish hidden divergence: This type of divergence takes place when the real market trends make a lower high, and the indicator makes a higher high.
Managing the divergence
For trade management, having a clear concept about divergence is important because explicit knowledge about it will help a trader realize when to pullback. It indicates that something in the market is changing, but it will not show when the trend or the movement will reverse. It suggests that a trader must adopt risk or money management techniques to control his trades.
The regular pattern of the momentum divergence can be utilized to predict the reverse movement of the price. When you see a bullish divergence, stay assured that the market is about to cancel its bearish movement, and when you see a bearish divergence, anticipate that the market is going to cancel the upward direction. It is regarded as a useful technical indicator because it sends a signal of the upcoming market condition earlier so that traders can take the necessary action. It is better to use an extra indicator to trade with divergence, and the moving average is considered one of the best indicators to use for this.
This article will be useful to you to helpdiscover the trading strategy that needs to be adopted in this scenario. Professionals can predict and execute their trades by analyzing the momentum divergence as it can provide a trader with an early signal.