In yesterday's post I said I would next take a look at how to validate the pattern of divergence between price and a technical indicator. Before I do that, it's worth understanding the reason why that is necessary.
Like all patterns associated with technical indicators, they are easy to "trade" in hindsights. Yesterdays post included a chart that demonstrated divergence - the pattern was in the centre of the chart and it was easy to see the price action that occurred as a result of the divergence. But trading occurs on the right hand edge, so here is an example of divergence from yesterday evening:
+div1.png)
This divergence is an indication that the bearish run is losing momentum and that there is potential for an upturn on price. However, as you can see from the chart below, a long trade would have almost certainly have failed:
+div2.png)
So validation of the divergence pattern is a process of applying a set of rules to assess whether or not the divergence is sufficiently compelling to place a trade. I'll discuss this in a subsequent post.
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