I'd like to talk about a trading method known as reverse divergence. Some people like to call it hidden divergence but I prefer reverse divergence because it is the reverse or opposite of your standard divergence.
A standard divergence is when price makes a new swing low but the oscillator diverges by making a higher low. This is called a bullish divergence and is considered bullish by many traders. A reverse divergence is when the oscillator makes a lower swing low while price makes a higher swing low. This is called a bullish reverse divergence.
In my opinion reverse divergence trades are more reliable than standard divergence trades because you will be always trading in the direction of the prevailing trend. In other words, a bullish reverse divergence will form in the direction of the trend while a standard bullish divergence will form against the trend in an attempt to pick a bottom. Sounds confusing right? Don't sweat it...The above chart will clarify what a bullish hidden divergence is.
Above is a chart daily chart of SOHU. Notice from points A to B the stochastic oscillator is making a lower low while the price action is making a higher swing low. If you look closely at the chart you will also notice that SOHU is in an uptrend for the past 7 months. SOHU has also been showing amazing relative strength compared to the S&P.
I actually bought SOHU today based on the above setup. My stop is right below $46.00 and my profit objective is around $66.00.
The above comments are not a recommendation to buy or sell SOHU. I'm simply just sharing with all of you what I am doing and why I am doing it.
Tuesday, November 27, 2007
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