How to Spot and Trade Bullish and Bearish Divergence Patterns

If on any one of the tops, a bearish engulfing exists, the double top has more strength.

Next, adjust the risk to the number of pips needed for a stop loss. 

However, before you start trading divergence setups, there are a few more points which we need to discuss further.

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Spotting price reversals and continuations through the interpretation of price action is an important skill for Forex traders to master.

Candlestick analysis can help make this process easier. Candle pattern interpretation does not only make navigating the market easier, but it can also be a useful trading tool. With this idea in mind we will focus on recognizing and trading one of the markets most clear cut price action signals, the bullish engulfing candle pattern.

What is a bullish engulfing pattern? A bullish engulfing pattern is a candlestick pattern normally foundafter a period of downward market pressure. Pictured above we can see that the bullish engulfing candle pattern is actuallycomprised of two completed candles!

The first candle will normally depict the end of the currency pairs established weakness. The regular divergence pattern is used to forecast an upcoming price reversal. When you spot a regular bullish divergence, you expect the price to cancel its bearish move and to switch to an upward move. When you see a regular bearish divergence, you expect the price to cancel its bullish move and switch to a downward move.

Divergence trading is an extremely effective way to trade Forex. The reason for this is divergence formations are a leading signal. This means that the divergence pattern is likely to occur before the actual move. This way, traders are able to anticipate and enter a trade right at the beginning of the new emerging move.

Reliable Indicators for Trading Divergences Since we discussed the four types of divergence patterns, we will now talk about the importance of the divergence indicator.

As I said, you need an indicator on your chart in order to discover divergence. The reason for this is that the price has to be in a divergence with something. It is simply impossible to trade divergence without having an extra indicator on the chart. So the question becomes, which indicator or indicators are best for divergence trading? In this manner, the indicator basically has a lagging character. However, the lagging character of the MACD concerns only its primary signal — the crossover signal.

The indicator also has two leading functions. Although the MACD is a lagging indicator in general, the divergence signal it gives us, is considered to have a leading character.

The image below will show you how MACD divergence trading works. At the bottom of the chart we have the MACD indicator, which is used to spot a bullish divergence. The blue lines on the chart show the divergence itself.

At the same time, the MACD creates higher bottoms. This scenario provides a nice opportunity for a long position. Stochastic Oscillator Another common oscillator used for divergence trading in Forex is the Stochastic Oscillator. The Stochastic consists of two lines which interact frequently between each other. At the top and the bottom of the indicator there are two areas — overbought and oversold areas.

The Stochastic indicator can be used for overbought and oversold readings. This is its primary purpose. However, the Stochastic Oscillator is an excellent tool for recognizing divergence trade setups.

In order to find a divergence between price action and Stochastic, you should look for discrepancies between the price direction and Stochastics tops or bottoms. It acts the same way as with the MACD. The reason for this is the dynamic character of the Stochastic. It simply gives more opportunities than the MACD.

However, since the signals can be more frequent, many of them might be false signals which need to be filtered out. Have a look at the image below. There are two divergences on the chart, which gives an opportunity for two trades. We start by analyzing the first case. We observe higher tops on the chart, while the Stochastic Oscillator creates lower tops. The price starts decreasing afterwards. However, the Stochastic suddenly starts closing with higher bottoms.

Greed has no place here. If you want more, just trail the stop loss on your trade. Keep in mind that success in Forex trading comes mostly from a disciplined approach, rather than being right all the times. Based on the above, the target depends on the risk. So, the focus shifts to the entry level.

And, the stop loss. Only after we define the risk, we apply the proper reward to it. Naturally, the bigger the time frame, the bigger the opportunities. Money management is a beautiful concept and traders adapt it to any situation. A bullish engulfing or a bearish one are powerful patterns. When that happens, a pullback follows.

Therefore, the right approach requires a technique called scaling. To scale in a position, traders split the original entry into two parts. So, the two entries are: One at the very close of the second candle. Hence, traders wait for the trade or place a pending order. Scaling into a Bullish Engulfing Pattern Scaling has multiple advantages.

Firstly, it gives trading a logical approach. Secondly, it offers a disciplined approach. The market must come to the entry level, or else. However, the engulfing pattern has even more qualities.

Basically, after such a pattern, the trader can move on. Just take the first trade. Next, wait for the pullback, if any. Place the stop loss at the lowest point of the bullish engulfing. Finally, set the 1: The chart below shows just this. If traders waited for the pullback, they would have missed this trade.

Not the case with scaling. For the bullish and bearish engulfing patterns, the or represent proper ratios to scale. Well, the example above shows it all: Confluence Areas with Candlestick Patterns The idea behind this principle is simple. The more patterns form in an area, the better.

If you want, the principle resembles the one used in support and resistance areas. The price finds it difficult to break an area with multiple support and resistance levels surrounding it. The same with candlestick patterns. Moreover, they work in combination with classic patterns too. The price of a currency pair reverses after it makes two attempts to break higher.

And, it failed both times, around the same price level. If on any one of the tops, a bearish engulfing exists, the double top has more strength.

Hence, traders combine the candlestick patterns trade with a regular double top trading. Scale into a bearish engulfing trade Use the double top measured move to trade the classic pattern The difference between comes from the time. Typically, the engulfing pattern reaches the take profit faster. The same thing applies to the triple top, the head and shoulders, and even the rising and falling wedge.

When an engulfing pattern forms too, the patterns confluence gives traders more faith in the upcoming trades. From a four-digit trading account to a five-digit quote, the leap happened virtually overnight. Hence, the way the traders see the market changed too. Imagine how a candlestick chart changes, when the opening and closing levels change. For this reason, candlestick patterns differ than other markets. Fantastic execution altered the patterns.

For example, a candlestick stock chart almost always has gaps. The stock market gaps frequently.

 

Market News Headlines 

Bullish Investors who believe that a stock price will increase over time are said to be bullish. Investors who buy calls are bullish on the underlying stock. That is, they believe that the stock price will rise and have paid for the right to purchase the stock at a specific price known as the exercise price or strike price.

After entering a bullish position in the market, naturally, you are what is called "long". Once again, price movement from this point up or down will change a bull’s account value in increments of the chosen market. Long, Short, Bullish and Bearish Every trader should understand these terms since they're used frequently in financial news, trading articles and in the papers. Long, short, bullish and bearish are terms used in all markets and on all time frames, regardless of whether you're day trading or investing, or trading soybeans or currencies. 

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