When it comes to trading, many traders search for a low risk way to sell at the top of a trend or buy at the bottom of a trend. The theory behind such a move is the closer you trade to the pivot point in price movement, the less risky your trade will be. This is where trading divergences can come in handy.
It is not easy to exactly describe what divergences are, but they have to do with comparing price action with movement of some type of indicator. Many different types of indicators can be used to spot divergences, but typically oscillators such as the RSI (Relative Strength Index) or CCI (Commodity Channel Index) are used. The reason oscillators are preferred is because they tend to make divergences easier to spot.
Divergences are often used to find fake moves that the markets sometimes make and then to trade off this analysis.
To spot a divergence you need to look at price and momentum. These two things usually move hand in hand. When the price is continually going higher the oscillator you are using should be going higher too and vice versa. When they are going in opposite directions, then this is what is called a divergence. Another type of a divergence is when the amplitude and the size of the move differ between the oscillator and the price.
There are both bullish and bearish divergences. Be careful you identify which is which because it makes a big difference in your trading. When trading a bullish divergence it is best to use a call option because the values are expected to continue to increase. When trading a bearish divergence it is best to use a put option because values should continue to go lower.
So divergences can be a very useful indicator when it comes to making successful binary options trades if you learn how to identify them properly.
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References and Further Reading:
1. High frequency trading strategy using the Hilbert transform (A Kablan, WL Ng – 2010)
2. Effectiveness of forex interventions in four Latin American economies (C Broto – 2012)
3. The Nonlinear Dynamic Relationship of Exchange Rates: Parametric and Nonparametric Causality testing (S Bekiros, CGH Diks – 2007)
4. Method and Apparatus for Real-Time Benchmarking (V Srivastava, P Barkhordarian – 2014)
5. Computer applications in the context of financial speculation (C Gallo, M De Bonis, P Palazzo – 2011)
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