Knowing when to get out of a trade is as important as knowing when to get in.
Richard Dennis was a successful trader who made over $300 million using a system based on divergence projections.
Dennis taught his system to a group of traders, known as The Turtles. The Turtles had a remarkable success, making money in different financial markets, but we already talked about that in this article.
Our job as traders is to detect the best zones when proposing a trade and one element that helps us in the search for these zones are the projections of divergences.
What is a divergence?
Divergences, in technical analysis, are contradictions, which you can see on a stock market chart, between the movement of the price and that of a particular technical indicator. If one goes up, the other goes down, or vice versa.
Learning to detect them will give you that extra security that we sometimes need.
What is a divergence projection?
Divergence projections are those areas where the price is most likely to reach once a divergence has occurred (bullish or bearish, it doesn't matter).
As you can imagine, the first step is to detect a divergence between the price and an indicator, such as the MACD or RSI.
Once we have located it, we can project it and detect the areas where the price is likely to stop.
It is essential to accompany this analysis always taking into account the relevant supports and resistances, they are key in a good technical analysis and more important than a projection.
Briefly, we tell you what are supports and resistances:
A support, it is a price that is below the current price (falling) and usually coincides with a previous low on the chart. When there is a support, it is normal that the purchase exceeds the sale due to the price decline and, therefore, this increases again.
The opposite happens at resistance. An uptrending price stops and starts to decline (usually coinciding with a previous peak on the charts). In this case, it is usual that the selling price exceeds the buying price and so it will change its trend and start to go down.
Finally, once you have your levels in place and projections drawn, you can now look for possible buy or sell zones.
What are the types of divergences?
We have two main types of divergences: bullish divergences and bearish divergences.
Bullish divergences: they occur when the price creates higher highs, but the technical indicator does not. Knowing this, it may be that the uptrend may be losing strength.
Bearish divergences: occur when the price creates lower lows, but the technical indicator does not respond to this. This indicates that the downtrend may be losing strength.
Several important tips and data
A divergence that grows rapidly is generally less reliable than a divergence that develops over a longer period of time.
Usually, we can be more confident in a divergence that occurs at a noticeable support or resistance level than a divergence that takes place at a less noticeable support or resistance level.
Always use a stop loss to protect your capital. It will allow you to exit a losing trade before your losses become too large.
Divergence projection levels are not exact. It is possible that the price may not reach the specific projection. Adjust the projection levels to account for the possible deviation.
Divergence projections are a useful tool, but they are not the only tool you should use. Always use other indicators optimized with the power of AI and tools to confirm the signals provided by divergence projections.
Remember that this is a game of probabilities and you must take into account more elements of context (Background trend, strength of the security, price-value tension,...) The projections of a divergence are one more element of context that help us to better understand a chart.
If you want to apply them and you have never done it before, do not forget to document everything in your trading diary so that you can measure 100% if they have helped you in your operations.
We will be happy to accompany you from countries all over the world from our Telegram community.
See you soon, trader!
For this article, prompts have been used to request information
interpreted and provided by AI (Google Bard). Written and edited
by Kevin David Terán and verified by Pedro Arizaleta and Erwin Sánchez