A Very Profitable Trading System By Oleg A. But

Copyright Information Copyright © 2006 Oleg A. But & Divergence-System.com http://Divergence-System.com Revision 2.14: February 2007

Author : Oleg Alexandrovich But Website : Divergence-System.com E-Mail : Sales@Divergence-System.com Publisher : Adam Burgoyne

REPRODUCTION AND OR TRANSLATION OF ANY PART OF THIS WORK BY ANY MEANS ELECTRONIC OR MECHANICAL INCLUDING PHOTOCOPYING BEYOND THAT PERMITTED BY COPYRIGHT LAW WITHOUT PERMISSION OF THE PUBLISHER IS UNLAWFUL.

Disclaimer & Risk Warning FOREX, futures, stock and options trading is not appropriate for everyone. There is a substantial risk of loss associated with trading these markets. Losses can and will occur. No system or methodology has ever been developed that can guarantee profits or ensure freedom from losses. No representation or implication is being made that using the TraderBO Divergence System methodology or system will generate profits or ensure freedom from losses. The contents of this e-book are for general information purposes only. Although every effort has been made to assure accuracy, the publishers can assume no responsibility for errors or omissions. Past performance is not indicative of future results.

1

In no event shall Divergence-System.com or its content providers be liable for any damages of any kind whatsoever with respect to the service, the material and the products provided herein.

Table of Contents

Preface 3

Recommended Brokerage 4

Description of Technical Indicators Used in the System 6

Support and Resistance 6

Supply and Demand 7

Traders’ Remorse 8

Resistance Becomes Support 9

(MACD) Moving Average Convergence/Divergence 10

Crossovers 10

Overbought/Oversold Conditions 11

Divergence 12

Stochastic Oscillator 13

Relative Strength Index Technical Indicator (RSI) 14

Williams’ Percent Range Technical Indicator (W%R) 16

TraderBO Divergence System 17

Money Management Rules for TraderBO Divergence System 17

Trading Rules for TraderBO Divergence System 18

Looking for Divergences 18

Finding Trade Opportunities 20

Trade 1. Enter on bearish divergence, exit on bullish divergence 20

Trade 2-3. Enter on close of prev. trade, exit on bearish divergence 25

Trade 3-4. Exit on bullish divergence, enter on bullish divergence 28

Trade 4-5. Exit on bearish divergence, enter on bearish divergence 34

Trade 5. Exit on bullish divergence 36

Calculation 1 (pips) 38

Trades 39

Calculation 2 (money) 40

Calculation 3 (increasing size of positions) 40

Conclusion 41

Additional Examples 42

Introduction to the “5 EMAs Forex Trading System” 56

2

A Final Word… 62

Preface

There are several types of divergences. Classic Divergence or so called Triple Divergence and Serial Divergence. There are also Hidden Divergence and Inter-market Divergence but we won’t be covering these types of Divergences in this book as they are not used in our trading system. Also Divergences are divided into bullish and bearish ones. Divergence is an indication that an end to the current trend may be approaching when the price of a security diverges from a value of a technical indicator. A bullish divergence occurs when a technical indicator is making new highs while prices fail to reach new highs. A bearish divergence occurs when a technical indicator is making new lows while prices fail to reach new lows. Both of these divergences are most significant when they occur at relatively overbought/oversold levels. Classic Divergence

Classic Divergence is when the price of a security diverges from a value of a technical indicator two or three times. For example, a price of a security is making two or three (Triple Divergence – the most commonly occurred divergence) new highs while prices fail to reach new highs.

Serial Divergence

It is the same divergence described above but this type of divergence just makes more than two or three highs or lows which are not confirmed by highs or lows of a technical indicator. There are even Serial Divergences which can make 7 or more highs or lows.

3

This book is dedicated to the correct use of divergences for very profitable trading.

Recommended Brokerage

To access the FOREX market, a trader requires an account (ideally a live account!) with a good brokerage. During my career as a trader and analyst, the best type of brokerage I have found is a non-dealing brokerage. Of course, even within the realms of non-dealing brokerages, the quality can vary tremendously and, for that reason, I'd like to recommend one that I personally rank very highly. You have the option of opening a live account and also a demo account so that you can get some experience with the strategies you will learn later in this book. If you are just beginning with FOREX then simply go for the demo account but, if you are more experienced, then I would suggest that you open a live account, too, as trading with a quality brokerage will make your overall experience that much better.

When you click the above image, a "Welcome" window will open. Decide on the type of account(s) you wish to open and then click the appropriate links below: Open a Demo Account Open a Live Account Deposit Funds into your Live Account Withdraw Funds from your Live Account Download Forms Assuming that you chose the Demo Account option, the screen will change to the "Request Demo Account" screen.

4

Once you have submitted your details (ensure your e-mail address is correct!) you will receive your Demo Account activation details. You will also have the opportunity to download MetaTrader4 - this free application combines your charting program and your trading platform in one easy-to-use system. MetaTrader4 is very intuitive to use, allows trades to be placed directly from the charts, supports many languages, has a comprehensive in-built help system plus many more features than I could possibly have time to describe in this e-book. Once you have opened your Demo Account and installed MetaTrader4 then you should move on to the next section for a description of the essential trading "tools" used in the course.

5

Description of Technical Indicators Used in the System

Here we’ll describe the technical indicators used in our system.

Support and Resistance

Think of prices for financial instruments as a result of a head-to-head battle between a bull (the buyer) and a bear (the seller). Bulls push prices higher, and bears lower them. The direction that prices actually move shows who is winning the battle.

Flat or Sideways Trend

6

Up Trend

Down Trend

Support is a level at which bulls (i.e. buyers) take control over the prices and prevent them from falling lower. Resistance, on the other hand, is the point at which sellers (bears) take control of prices and prevent them from rising higher. The price at which a trade takes place is the price at which a bull and bear agree to do business. It represents the consensus of their expectations. Support levels indicate the price where the majority of investors believe that prices will move higher. Resistance levels indicate the price at which the majority of investors feel prices will move lower. Investor expectations, however, change with time, and they often do so abruptly. The development of support and resistance levels is probably the most noticeable and re-occurring event on price charts. The breaking through of support/resistance levels can be triggered by fundamental changes that are above or below investors’ expectations (e.g. changes in earnings, management, competition, etc.) or by self-fulfilling prophecy (investors buy as they see prices rise). The cause is not as significant as the effect: new expectations lead to new price levels. There are also support/resistance levels which are more emotional.

Supply and demand

There is nothing mysterious about support and resistance: it is classic supply and demand. Remembering your “Economics 101” class, supply/demand lines show what the supply and demand will be at a given price.

7

The supply line shows the quantity (i.e. the number of shares) that sellers are willing to supply at a given price. When prices increase, the quantity of

sellers also increases as more investors are willing to sell at these higher prices. The demand line shows the number of shares that buyers are willing to buy at a given price. When prices increase, the number of buyers also increases but, at the same time, the subsequent price increases simultaneously decreases the number of remaining investors willing to buy at these new, higher prices and often result in a pullback. At any given price, a supply/demand chart shows how many buyers and sellers there are. In a free market, these lines are continually changing. Investors’ expectations change, and so do the prices buyers and sellers feel are acceptable. A breakout above a resistance level is evidence of an upward shift in the demand line as more buyers become willing to buy at higher prices. Similarly, the failure of a support level shows that the supply line has shifted downward. The foundation of most technical analysis tools is rooted in the concept of supply and demand. Charts of prices for financial instruments give us a superb view of these forces in action.

Traders’ remorse

After a support/resistance level has been broken, it is common for traders to ask themselves to what extent these new prices represent the facts. For example, after a breakout above a resistance level, buyers and sellers may both question the validity of the new price and may decide to sell. This creates a phenomenon that is referred to as "traders’ remorse": prices return to a support/resistance level following a price breakout. The price action following this remorseful period is crucial. One of two things can happen: either the consensus of expectations will be that the new price is not warranted, in which case prices will move back to their previous level; or investors will accept the new price, in which case prices will continue to move in the direction of the break through. In case number one, following traders’ remorse, the consensus of expectations is that a new higher price is not warranted, a classic "bull trap" (or false breakout) is created.

8

For example, the prices broke through a certain resistance level (luring in a herd of bulls who expected prices to move higher), and then prices dropped back to below the resistance level leaving the bulls holding overpriced stock.

Similar sentiment creates a bear trap. Prices drop below a support level long enough to get the bears to sell (or sell short) and then bounce back above the support level leaving the bears out of the market. The other thing that can happen following traders’ remorse is that investors’ expectations may change causing the new price to be accepted. In this case, prices will continue to move in the direction of the penetration. A good way to quantify expectations following a breakout is with the volume associated with the price breakout. If prices break through the support/resistance level with a large increase in volume and the traders’ remorse period is on relatively low volume, it implies that the new expectations will rule (a minority of investors are remorseful). Conversely, if the breakout has moderate volume and the "remorseful" period has increased volume, it implies that very few investor expectations have changed and a return to the original expectations (i.e. original prices) is warranted.

Resistance becomes support

When a level of resistance is successfully broken, that price level then becomes a level of support. Similarly when a support level is successfully broken, that price level becomes a resistance level. The reason for it is that a new "generation" of bulls appears who refused to buy when prices were low. Now they are anxious to buy at any time the prices return to the previous level. Similarly, when prices drop below a support level, that level often becomes a resistance level that prices have a difficult time breaking through. When prices approach the previous support level, investors seek to limit their losses by selling.

9

(MACD) Moving Average Convergence/Divergence

MACD

The MACD proves most effective in wide-swinging trading markets. There are three popular ways to use the Moving Average Convergence/Divergence: crossovers, overbought/oversold conditions, and divergences.

Crossovers

The basic MACD trading rule is to sell when the MACD falls below its signal line. Similarly, a buy signal occurs when the Moving Average Convergence/Divergence rises above its signal line. It is also popular to buy/sell when the MACD goes above/below zero.

10

Overbought/oversold conditions

The MACD is also useful as an overbought/oversold indicator. The principle is that when the shorter moving average pulls away dramatically from the longer moving average, as indicated on the chart above, it is likely that the security price is overextending and will soon return to a more realistic level. This applies to instances where the MACD is rising and falling.

11

Divergence

An indication that an end to the current trend may be near occurs when the MACD diverges from the security. A bullish divergence occurs when the Moving Average Convergence/Divergence indicator is making new highs while prices fail to reach new highs. A bearish divergence occurs when the MACD is making new lows while prices fail to reach new lows. Both of these divergences are most significant when they occur at relatively overbought/oversold levels. We’ll be using MACD for:

finding divergence with the price of a currency pair

12

indicating an alert for opening a trade position

Stochastic Oscillator

Stochastic Oscillator

The Stochastic Oscillator Technical Indicator compares where a security’s price closed relative to its price range over a given time period. The Stochastic Oscillator is displayed as two lines. The main line is called %K. The second line, called %D, is a Moving Average of %K. The %K line is usually displayed as a solid line and the %D line is usually displayed as a dotted line. There are several ways to interpret a Stochastic Oscillator - three popular methods include:

1. Buy when the Oscillator (either %K or %D) falls below a specific level (e.g., 20) and then rises above that level. Sell when the Oscillator rises above a specific level (e.g., 80) and then falls below that level

2. Buy when the %K line rises above the %D line and sell when the %K

line falls below the %D line

3. Looking for divergences - for instance: where prices are making a series of new highs and the Stochastic Oscillator is failing to surpass its previous highs.

We'll be using the Stochastic Oscillator for:

finding divergence with the price of a currency pair

13

indicating an alert for opening a trade position

Relative Strength Index Technical Indicator (RSI)

Relative Strength Index

The Relative Strength Index Technical Indicator (RSI) is a price-following oscillator that ranges between 0 and 100. When Welles-Wilder first introduced the Relative Strength Index, he recommended using a 14-day RSI, however, since then, the 9-day and 25-day Relative Strength Index indicators have also gained popularity. A popular method of analyzing the RSI is to look for a divergence in which the security is making a new high but the RSI is failing to surpass its previous high. This divergence is an indication of an impending reversal. When the Relative Strength Index then turns down and falls below its most recent trough, it is said to have completed a "failure swing". The failure swing is considered a confirmation of the impending reversal. There are several common ways of using Relative Strength Index for chart analysis:

Tops and bottoms

The Relative Strength Index usually tops above 70 and bottoms below 30. It usually forms these tops and bottoms before the underlying price chart;

Chart Formations

The RSI often forms chart patterns such as head and shoulders or triangles that may, or may, not be visible on the price chart;

14

Failure swing (Support or Resistance penetrations or breakouts)

This is where the Relative Strength Index surpasses a previous high (peak) or falls below a recent low (trough);

Support and Resistance levels

The Relative Strength Index shows, sometimes more clearly than prices themselves, levels of support and resistance.

Divergences

As discussed above, divergences occur when the price makes a new high (or low) that is not confirmed by a new high (or low) in the Relative Strength Index. Prices usually correct and move in the direction of the RSI.

In this system, we’ll be using Relative Strength Index as a secondary confirmative indicator for entries and exits of trades.

15

Williams’ Percent Range Technical Indicator (W%R)

Williams’ Percent Range

The Williams’ Percent Range Technical Indicator (W%R) is a dynamic technical indicator which determines whether the market is overbought or oversold. The Williams’ %R is very similar to the Stochastic Oscillator, the only real differences being that W%R has an inverted scale and the Stochastic Oscillator has internal smoothing. To show the indicator in this ‘upside down’ fashion, one places a minus symbol before the Williams Percent Range values (for example: -30%), however, one should ignore the minus symbol when conducting analysis. Indicator values ranging between 80 and 100% indicate that the market is oversold. Indicator values ranging between 0 and 20% indicate that the market is overbought. As with all overbought/oversold indicators, it is best to wait for the security’s price to change direction before placing your trades. For example, if an overbought/oversold indicator is showing an overbought condition, it is wise to wait for the security’s price to turn down before selling the security. An interesting phenomenon of the Williams Percent Range indicator is its uncanny ability to anticipate a reversal in the underlying security’s price. The indicator almost always forms a peak and turns down a few periods before the security’s price peaks and turns down. Likewise, the Williams Percent Range usually creates a trough and turns up a few periods before the security’s price begins to rise.

16

We will be using the Williams’ Percent Range as an overbought/oversold indicator, which will be confirming overbought/oversold levels of the corresponding security.

TraderBO Divergence System

This trading system represents a set of rules for correct and profitable trading with divergences.

Money Management Rules for the TraderBO Divergence System

Important! The Money Management Rules mentioned below are intended strictly for the TraderBO Divergence System. Use of the given rules with other trading systems can lead to unjustifiable losses. The TraderBO Divergence System is intended for short-term trading with carry of opened positions to the next day or beyond. I recommend placing Stop Loss Orders 60-100 pips away from trade entry levels and risking no more than 10% of the available balance on any trade.

17

Now we shall go through the trading rules for the TraderBO Divergence System in some detail.

Trading Rules for the TraderBO Divergence System

There is only one main rule – entering on one divergence and exiting on the opposing divergence. If you enter a trade on a Bullish Divergence then you should exit the trade on a Bearish Divergence while simultaneously opening an opposing position.

Looking for divergences

First, we need to find a divergence with the MACD Technical Indicator. After that we should confirm the divergence with the Stochastic Oscillator Technical Indicator. To do this, we are going to use two time frames:

240 min. (4H) and 60 min. (1H) The 240 min. time frame is for finding divergences and the 60 min. time frame is for confirmation of trade alerts.

Moving Average Convergence/Divergence (MACD)

There are two types of divergences - Bullish divergences and Bearish divergences.

Bullish Divergence

A bullish divergence occurs when the Moving Average Convergence/Divergence indicator is making new highs while prices fail to reach new highs.

Bearish Divergence

A bearish divergence occurs when the MACD is making new lows while prices fail to reach new lows. Both of these divergences are most significant when they occur at relatively overbought/oversold levels.

18

Let’s look at parts of the chart below (it’s been divided into two parts). We’ll consider the time period from 19 August 2005 to 29 September 2005.

This chart represents the first part of the defined time period.

This chart represents the second part of the defined time period.

19

Now let’s see what trade opportunities we can find on these charts.

Finding trade opportunities

First we should find divergences by means of the MACD and Stochastic indicators. After that, we must confirm our entry/exit points using the RSI and W%R indicators.

Trade 1: Enter on a bearish divergence, exit on a bullish divergence on the 240 min (4H) chart using MACD and Stochastic indicators, confirmation on the 60 min (1H) chart using RSI and W%R indicators.

Entering trade 1

Take the first part of the first chart:

What do we see on the left side of the chart? We see a high (1.2770) [marker 1]. We may decide that after this high, the price may go down and, yes, it does! The price goes down but the MACD remains positive [marker 2].

20

It means that we can wait for the price to return to the direction of the trend – up, at least to 1.2770. Therefore, we should set an alert at the 1.2770 price level. The alert triggers on 2005.08.24. Moreover, up until that time, we see bearish divergence on the MACD and Stochastic indicators [markers 3, 3.1]. That will not do for us. We need to confirm the alert on the 60 min. chart with the RSI and W%R technical indicators. All is fine! W%R is higher than -20 and RSI is higher than 70 [markers 4, 4.1]. It is a very good opportunity to open a short position and so we did.

21

After our entry, a very strong bearish movement occurred. Now we need to wait for a bullish divergence, close our trade and maybe open a new trade in the opposite direction.

Exiting trade 1

Looking for an opportunity to exit the trade and open in the opposite direction. Note: This chart is a continuation of the previous one.

What can we see on the left-hand chart? We see a low (1.2536) [marker 1]. We may decide that after this low, price may go up and, yes, it did! The price goes up but the MACD remains negative [marker 2]. It means that we can wait for price to return to the direction of the trend – down, at least to 1.2536. Therefore, we should setup an alert at the 1.2536 price level.

22

The alert triggers on 2005.08.26 [marker 3]. At this point we don’t see a bullish divergence on the MACD but we see a strong bullish divergence on the Stochastic indicator [marker 4].

That will not do for us. We need to check out what is happening on the 60 min. chart with the RSI and W%R technical indicators. They are okay - W%R is lower than -80, but the RSI is higher than 30 [markers 5, 5.1]. Of course, the ideal scenario would be to close the previous position and open a long position (i.e. exit and reverse) but we don’t do it yet. We need to wait until the MACD shows a bullish divergence like the Stochastic indicator does. Interestingly, the 60 min time frame is showing a serial divergence.

Note: In this scenario you can close the open (short) position but it would be better to wait a while before opening a new, long position because it is rather difficult to identify the end of a serial divergence. However, ultimately, it is up to you.

23

Having waited 3 days, on 2005.08.29 we found our trading opportunity. Now we see a bullish divergence on the MACD [marker 6], W%R is now less than -100 and while RSI is 32, it is higher than at the previous low of the

price [markers 7, 7.1]. It is very good opportunity to close the open position and to simultaneously open a long position. Unfortunately, we had been waiting for 3 days but won only 26 pips. What can I say – the market is the market! ☺ …It is always better to wait a little in order to be doubly sure - at least, I think so.

24

After our entry, a very strong bullish movement occurred. Now we need to wait for a bearish divergence, close our trade and maybe open a new trade in the opposite direction.

Trade 2-3. Enter on close of previous trade, exit on a bearish divergence on the 240 min (4H) chart with MACD and Stochastic, confirmation on the 60 min (1H) chart using RSI and W%R technical indicators.

Entering trade 2

It is already clear that, in this case, the exit point of the current trade is to be used as the entry point for the next trade.

Exit trade 2 and Enter trade 3

It is a very interesting case! What are we getting at this time? We can see the high (1.2686) [marker 1].

25

We feel that after this high, price may well go down and, as expected, it does. The price goes down and MACD still remains negative [marker 2] which means that we must wait for further developments in the price action. As always, we set an alert at the price of the previous high (1.2686) which triggers on 2005.08.30 [marker 3]

Please note that we don’t see any bearish divergence on the MACD. There is only the high point on the Stochastic [marker 4]. That isn’t enough to justify a position so we need to check out what is happening on the 60 min. time frame with the RSI and W%R technical indicators. Good news! W%R is higher than -20 and RSI is higher than 70 [markers 5, 5.1]. Note: Although the W%R and RSI [markers 5, 5.1] have quite high (overbought) values, our level (1.2686) was still broken through [marker 6]. Moreover, the one hour candlestick that broke through that level (1.2686) closed even higher and the following candlestick went higher still, indicating a continuation of the up trend.

26

I think you now understand that it is a very difficult situation. Therefore, it would be better to close our long position and that is what we did but, at the same time, we are not going to open an opposing (short) position just yet (see note above) - it is better to wait a little. At the very least, we should wail until the W%R and RSI indicators show maximal values once more.

About two hours later we got a bearish candlestick [marker 7] and the W%R and RSI indicators were showing maximal values [markers 8, 8.1]. Moreover, we had a bearish divergence on the MACD [marker 9] and noted that the price was going up but the RSI was not [marker 10]. This gave us an opportunity to enter a short position, which we did. After our entry, a very strong bearish movement occurred. Nothing to do now except sit back and wait for a bullish divergence, close our trade and think about opening an opposing position.

27

Trade 3-4. Exit on a bullish divergence, enter on a bullish divergence on the 240 min (4H) chart using the MACD and Stochastic indicators, confirmation on the 60 min (1H) chart using the RSI and W%R technical indicators.

Exiting trade 3 and Entering trade 4

We are now looking for an opportunity to exit trade 3 and open an opposing position. Note: This chart is a continuation of the previous one.

It’s time to look at the next chart section. We can see a good low (1.2247) [marker 1] so it may be time for the price to go up.

28

Not wishing to disappoint us, it does just that! The price goes up but the MACD remains negative [marker 2] so we can wait for price return to the direction of the trend – down, at least to (1.2247). As usual, we set our alert – this time at 1.2247 – which triggers on 2005.09.05 [marker 3]. Unfortunately, at that point in time, we can’t see a bullish divergence on the MACD but we can see a strong bullish divergence on the Stochastic indicator [marker 4]. Once again, we need to check the 60 min. chart to see what is happening with the RSI and W%R technical indicators. W%R is lower than -100 and RSI is lower than 30 [markers 5, 5.1] – great! It is a very good opportunity to close our short position and immediately open an opposing (long) position. Now I’ll explain why. The 1-hour candlestick which has broken through the 1.2247 level has not closed lower than that level [marker 6] and the next candlestick went even higher. It is indicating an impending reversal of the down trend. Moreover, on the 60 min chart, we can see very obvious bullish divergences both on the W%R and RSI indicators [markers 7, 7.1]. It confirms the trade alert and, therefore, we open a long position. Now trade 4 is open! After our entry, a very strong bullish movement occurred so we need to wait for a bearish divergence so that we can close our trade and look to reverse our position. Trade 4 is the most profitable one in this manual! It runs up from 1.2262 to 1.2809. That equates to 547 pips over 15 days.

29

Let’s analyze trade 4 using the chart above. Whilst dissecting this trade, we shall also touch on a technique that helps to prevent you closing profitable trades too early (this technique has one important secret that is explained in the 5 EMAs Forex Trading System, which you can buy at any time ☺). Note: As you can see there are no indicators on the chart - it has been done deliberately. And so, we are already in the market and it is obvious that a very strong bullish trend has developed. Also we see a series of highs [markers 1, 2, 3, 4 & 5] which are potential points for exiting the position. Now we shall add technical indicators to explain why we are not going to exit the position at this time.

30

Having adWhat can Yes, the Mcrossed ovpoint, we indicators.Stochastic First, this [marker Second, wthat the fathe zero libut, for us Further alindicator [the MACD

6 7

8

9

10

1

ded indicators,we see? Well, s

ACD is in the ner and is abov

don’t have any Further along, indicator [ma

bearish diverge8].

e don’t have anst MA (histograne. This would , simply indica

ong, we got themarker 10] b.

we get a cletart from th

egative zonee its signal

divergence o however, wrker 7].

nce on the S

y divergencm) [markeindicate a ‘butes that the t

next bearishut, again, we

1

arer image of the market’s behavior. is area of the chart.

but its fast MA (histogram) has MA [marker 6]. Moreover, at this n either the Stochastic or MACD

e got a bearish divergence on the

tochastic indicator is very small

e on the MACD and, in addition, we see r 9] of the MACD has crossed above y entry’ in standard MACD systems rend should continue.

divergence on the Stochastic don’t have a bearish divergence on

31

No divergence between the price and the MACD [marker 11] indicator means that it is too early to exit from our current position. Remember, we should wait for divergences on both the MACD and Stochastic indicators. Had we taken just this bearish divergence on the Stochastic indicator without confirmation from the MACD then we could have gained about 100 pips (dark red lines at 1.2638 and 1.2535 on the chart). It is a pity but it is better to miss a trade than to lose money. Now let’s go to the other chart so that we can look at some other market conditions more clearly.

Up to this point, a very good up-trend has developed and so, as we’ve already got three lows, we can draw a trend line. We begin from the first low [marker 1] and continue to the third one [marker 2]. Please note that although we have three lows, we should take account of just the first and third as they are the main ones. The fact that the second (minor) low breaks through our trend line a little [marker 3] can be ignored. Now, let’s go back to our divergences.

32

This area is deliberately blanked out to obscure future price action.

1 3

2 6

4

5

Again, we encounter a bearish divergence on the MACD [marker 4] but we don’t have any divergence on the Stochastic indicator [marker 5]. What we do have is a very strong bullish trend which is confirmed both by our trend line and by the MACD! Moreover, the last move downward has not come close to the trend line [marker 6]. Also, the MACD has been very positive for quite a long time so, all in all, everything indicates that it is very early for closing our position. Let’s proceed to the next chart…

Only now we eventually meet a bearish divergence, confirmed by both indicators [markers 5, 5.1].

33

5

5.1

Trade 4-5. Exit on a bearish divergence; enter on a bearish divergence on the 240 min (4H) chart using the MACD and Stochastic indicators, confirmation on the 60 min (1H) chart using the RSI and W%R technical indicators.

Of course, it is the perfect situation to exit trade 4 and enter trade 5.

Exit trade 4 and Enter trade 5

We’ve already found an opportunity to exit trade 4 and, as it happens, it is the perfect time to open an opposing position. As you may have noticed with trade 4, we were not using the 60 min. chart for confirmation of alerts. My goal was to teach you how work without them in certain situations. Now let’s look at the 60 minute chart.

34

2

1.1 1

As we would expect, on the 60 minute chart there is confirmation of our decision to exit trade 4 and enter trade 5 - bearish divergence on the RSI and, in addition, the RSI indicator was in the upper region [markers 1, 1.1] plus the W%R indicator is showing a strongly ‘overbought’ situation [marker 2].

35

Ok! Time to open a short position (Trade 5).

Trade 5. Exit on a bullish divergence on the 60 min (1H) chart using the RSI and W%R technical indicators with confirmation from price touching the trend line on the 240 min (4H) chart and the 240 min Stochastic.

Trades with divergences go on and on but Trade 5 is our last trade in this manual. After that you’ll definitely be able to find divergences in any financial market. So, let’s finish with this last transaction. Trade 5 will demonstrate to you one more method of exiting/entering a position and it will add to your trading arsenal to help spot additional trade opportunities. Being honest, this method is very common so really only beginners should be unaware of it.

Close trade 5

36

This is why we have been hiding the future market behavior on the earlier charts - only now can we see how correctly our trend line was originally drawn (maroon circle).

And so, we reach a point where the price clearly touches th[marker 1]. But how can we be sure that the price will notlower that the trend line? For this, we simply turn to our 60confirmation. On the 60 minute chart we can see bearish divergences, boand the RSI indicators [markers 2, 2.1]. Also, on the 240can see that the Stochastic indicator is oversold [marker 3is positive [marker 4]. It is obvious that we can close trade 5 and open trade 6, doany apprehension. After our entry, a very strong bullish move occurred and wetrading but, as I said earlier, 5 trade is last trade in this ma

37

1

4

3

2

2

The price is touching the trend line butonly on the

60-min. chart

.1

e trend line keep dropping minute chart for

th on the W%R minute chart we ] and the MACD

ing so without

could continue nual.

I hope that you now understand enough to keep trading without me and close Trade 6 on your own ☺ As for me, I’d close Trade 6 at the 1.2961 price level. Now, before finishing this manual, I suggest that we make some calculations of hypothetical profit.

Calculation 1 (pips)

The value of a pip for 1 standard lot of USD/CHF is normally 10 CHF, however, the value of a pip for a given currency pair can vary between brokerages. For floating currency rates, the value of pips is calculated like this: Profit in pips * 10 CHF / Currency rate on close. For example: Here we’ll calculate our profit in Swiss francs (for one lot) for our first trade and the profit in US dollars. Enter Trade 1 at 1.2770 - Exit at 1.2536 Closing price of our first trade is 1.2536. So: 1.2770 - 1.2536 = 234 pips … is our profit in pips. Next: 234 pips * 10 CHF = 2,340 CHF … is our profit in Swiss francs. 2,340 CHF / 1.2536 (final rate of the trade) = 1,866.62 USD Note If you want to know the value of one pip for the USD/CHF currency pair for 1 standard lot ($1,000), you should just divide 10 CHF by the current exchange rate of USD/CHF. In our case, 10 CHF / 1.2536 = 7.97 USD.

38

Trades

Enter Trade 1 at 1.2770 - Exit at 1.2536 Trade 1: 234 pips profit Enter Trade 2 at 1.2536 - Exit at 1.2686 Trade 2: 150 pips profit Enter Trade 3 at 1.2686 - Exit at 1.2247 Trade 3: 439 pips profit Enter Trade 4 at 1.2247 - Exit at 1.2811 Trade 4: 564 pips profit Enter Trade 5 at 1.2811 - Exit at 1.2654 Trade 5: 157 pips profit Enter Trade 6 at 1.2654 - Exit at 1.2961 Trade 6: 307 pips profit 1,851 pips profit from 6 trades between 2005.08.19 and 2005.09.26 - a period of just 39 days. If you were entering and exiting at better levels then you could easily have boosted the profit to more than 2,000 pips.

39

Calculation 2 (money)

So, the value of one pip of USD/CHF is 10 CHF Note: The value of each pip of USD/CHF floats; therefore, the final value depends on the closing price of the trade. If, for example, the value of a pip was fixed at $8, our profit for those 39 days would be $14,808.

Calculation 3 (increasing size of positions)

Take note here! If our potential profit grows, we can increase the size of the positions we open... We have already stated that our Money Management Rules allow us to use 10% of our account balance when opening each trade. So, how does that affect things? Let’s see! Our first trade gave us 234 pips (worth $1,867) meaning that, for our second trade, we can open a larger position. We calculate our lot size for Trade 2 (which gave 150 pips) as follows: ($10,000 + $1,187) / 10 = $1,187 i.e. 1.20 lots That would change the profit of Trade 2: 150 * $7.80 = $1,170 + ($1,170 / 5) = $1,404 instead of $1,170 with one standard lot ($1,000) We calculate our lot size for Trade 3 (which gave 439 pips) as follows: ($10,000 + $1,187 + $1,404) / 10 = $1,259 i.e. 1.30 lots. 439 * $8.00 = $3,512 + ($3,512 / 3) = $4,682 instead of $3,512 with one standard lot ($1,000) We calculate our lot size for Trade 4 (which gave 564 pips) as follows: ($10,000 + $1,187 + $1,440 + $4,682) / 10 = $1,730 i.e. 1.70 lots (we ignore values from the 2nd decimal place onwards i.e. 1.70, not 1.73 lots). 564 * $7.80 = $4,430 + ($4,430 / 1.4) = $7,594 instead of $4,430 with one standard lot ($1,000) We calculate our lot size for Trade 5 (which gave 157 pips) as follows:

40

($10,000 + $1,187 + $1,440 + $4,682 + $7,594) / 10 = $2,490 i.e. 2.50 lots.

157 * $8.00 = $1,256 + ($1,256 * 2.5) = $4,396 instead of $1,256 with one standard lot ($1,000) Finally, we calculate our lot size for Trade 6 (which gave 307 pips) as follows: ($10,000 + $1,187 + $1,440 + $4,682 + $7,594 + $4,396) / 10 = $2,929 i.e. 3.0 lots. 307 * $7.70 = $2,364 + ($2,364 * 3) = $9,456 instead of $2,364 with one standard lot ($1,000) That is the real power of the Money Management Rules!

Conclusion

I think you can see the difference…. Three scenarios, three very different results:

Entering and exiting at worse-case price levels and constantly using one fixed standard lot ($1,000) per trade gave us 1,851 pips or $14,808 (assuming a rounded USD/CHF pip value of $8 to simplify the calculation).

Entering and exiting at better price levels and constantly using one fixed standard lot ($1,000) per trade would have given us about 2,000 pips or $16,000 (assuming a rounded USD/CHF pip value of $8 to simplify the calculation).

Entering and exiting at worse-case price levels but constantly increasing the position size per trade following Money Management Rules (10% of current balance), with the correct floating pip value, we get 1,851 pips but a substantially higher profit of $28,719 instead of just $14,808!

The final account balance would be $10,000 + $28,719 = $38,719! The figures shown in the previous few sections are all very well but the main point of the exercise was to help you reach this important conclusion:

Trading divergences correctly can be very, very profitable!!!

41

Additional Examples

As the material, up to now, has concentrated on one particular period of time and on a single currency pair, this section is intended to show that trade opportunities arise regularly and consistently. The selection of charts (no more calculations, you’ll be glad to know!) show some examples of other divergence trades in the four major pairs (GBP/USD, EUR/USD, USD/CHF and USD/JPY) between December 2005 and late February 2007. Each example consists of three charts:

1. a 4 hour setup chart – this is where trade opportunities are identified, 2. a 60 min. confirmation chart, and

3. a 60 min. trade overview chart so you can see the trade from start to

finish

42

So… on with the examples!

Trade 1 USD/CHF (2005.12.30-2006.01.04) - 426 pips profit

43

Trade 2 USD/CHF (2006.01.06-2006.01.11) - 136 pips profit

44

Trade 3 GBP/USD (2006.01.24-2006.02.30) - 239 pips profit

45

Trade 4 GBP/USD (2006.02.08-2006.02.09) - 195 pips profit

46

Trade 5 USD/JPY (2006.07.19-2006.07.21) - 192 pips profit

47

Trade 6 EUR/USD (2006.08.10-2006.08.14) - 190 pips profit

48

Trade 7 EUR/USD (2006.11.01-2006.11.03) - 100 pips profit

49

Trade 8 USD/JPY (2006.11.24-2006.11.27) - 219 pips in profit

50

Trade 9 USD/JPY (2007.02.06-2007.02.09) - 198 pips profit

51

Trade 10 EUR/USD (2007.02.06-2007.02.09) - 130 pips profit

52

Trade 11 GBP/USD (2007.02.13-2007.02.15) - 270 pips profit

53

Trade 12 USD/CHF (2007.02.19-2007.02.20) - 50 pips profit

54

So, as you can see, divergences occur frequently and almost anywhere you care to look for them. Are these the only examples to have occurred over the past two years? Of course not! There are many other great divergence trades on the charts but it is up to you – look upon it as ‘homework’ – to go and find them. The exercise will hone your skills and help you to identify opportunities when you start trading for real. The next level:- Learn how to turn $1,000 into $1,000,000+ in just 24 months! Get a copy of my main course: “Building Millions on FOREX” which reveals the secrets of my best FOREX trading system, the “5 EMAs Forex Trading System”.

55

I use this system everyday (except weekends, of course ☺) to trade both my own and also managed accounts for investors.

Introduction to the

“5 EMAs FOREX Trading System”

56

This is a thoroughly comprehensive course that is suitable for all levels of experience.

Here is the Table of Contents:

57

58

59

60

61

Now take a look at some real micro trades from a live account. All trades were closed using Exit strategy №1 (most conservative)

A final word….

You are now armed with knowledge that many other traders do not possess – if nothing else, that should give you an edge in the markets. Just remember to be aware of your biggest enemy when trading…. Yourself! Most traders could make a decent return if they simply got to grips with their emotions: greed and fear will absolutely kill you if you cannot control them. This is where strict (mechanical) trading rules will save you – if you have a set of rules to follow then you will enter and exit trades at the correct times, maximize your profits and minimize your losses. Now you understand divergences, move up to the next level with the “5 EMAs Forex Trading System”. May I wish you a long and prosperous trading career,

62

Oleg A. But