Anticipate Higher Highs and Lower Lows Earlier with the Divergent Bar

2021-06-23 | Allison Ostrander

The Divergent Bar can help determine the potential move of one (or potentially up to 3) bars into the future. It is a tool used to identify if you will see a potential higher high or lower low within the next three bars. Depending on the time frame, you can use this tool to make for some great short term trades that you may only hold overnight, or even longer term swing setups. The overall win rate using my Overnight Profit Strategy with this indicator continues to remain above 80%.

There are two types of divergent bars, the bullish divergent bar and the bearish divergent bar.

1. Bullish Divergent Bar: A bullish divergent bar signals a potential move to a higher high compared to the high of the bar forming the bullish divergent bar. This higher high typically happens within the next bar, but can take up to 3 bars to follow through on the signal. For example, for a bullish divergent bar, we will typically see some sort of higher high within the next 3 bars compared to the bar that printed. This is why I typically like to give myself some time in the expiration to allow for those three bars to print. On a daily chart, this means wait to see a higher high within the next 3 days, to allow the trade to follow through.

2. Bearish Divergent Bar: Alternatively, a bearish divergent bar signals a potential move to a lower low compared to the low of the bar forming the Bearish Divergent Bar. This lower low typically happens within the next bar, but can take up to 3 bars to follow through on the signal. In a bearish divergent bar, we will typically see a lower low within the next 3 bars compared to the one that printed. For example, it could take up to 3 hours on an intraday hourly chart for the signal to follow through.

I have found that in Bullish Trends, Bearish divergent bars become a counter trend signal and therefore can have a smaller probability of following through on the lower low. Whenever I see a Bearish Divergent Bar in a Bullish Trend, I typically use it as a sign to consider taking profits, or to keep a close eye on a potential move back into support for me to jump back in with a bullish trade again matching with the trend.

Consolidation: If a divergent bar prints back to back, whether it is a bearish and bullish divergent bar or two bearish and two bullish bars, this can start to be an overall sign of consolidation. It does not mean the signal will not follow through, however it might not be as dramatic of a follow through for a higher high or lower low.

In the example, you can see in the middle box that it took 3 bars, or 3 days, to follow through and print a lower low, showing how you have to be patient. The signals technically followed through but it wasn’t a very strong lower low and was a less dramatic move. However, it might not always be as dramatic. It just hints at an overall sign of consolidation.

If you decide to take a trade off a divergent bar during consolidation, there are two things you can take into consideration.

1. The first thing to consider is your Risk. You may look to hold a smaller capital risk in the trade, in case it does not follow through or is not as dramatic of a higher high or lower low.

2. The other thing to consider is your Price Target. Consider taking a smaller price target with a lower good ‘till cancel (GTC). This increases the possibility that the trade will fill and you can still take a quick profit. That’s why you’ll see in my examples, I’m only looking at a 15 or 20 cent profit. It may not be the largest profit, but during that time on an intraday move, I’ve protected my initial capital risk completely, I’ve still managed to lock in a small profit, and I still have a butterfly trade left that I will either cash settle into the close that day, or can close out the next day, ideally taking that profit on the trade itself.

3. Also consider doing strategies that benefit from chop, like credit vertical spreads, or unbalanced butterflies. This can be a great trade setup if the divergent bar doesn’t necessarily see a strong follow through. As long as the short strike remains out of the money, you can typically take a profit.

How to Read a Divergent Bar: The divergent bar indicator gives a clear signal of a bullish or bearish divergent bar just by a change in the bar’s color. You can customize the color for the bullish divergent bar and bearish divergent bar to whatever colors you would like. I chose the light pink to represent a bearish divergent bar and a cyan blue to represent a bullish divergent bar. That’s what works best for me psychologically to determine which is a bullish versus bearish divergent bar.

Which time frames does the Divergent Bar work on? The divergent bar indicator can be used on any time frame. It can be used from an intraday time frame all the way to a monthly time frame. Depending on the trading strategy I’m using, I will use the bar on different time frames.

Here’s an example of SPX on an hourly intraday chart:

The Divergent Bar indicator only needs data of the prior bar and the current bar to form a proper signal. This is a great benefit to symbols who have had recent IPOs. If you wanted to trade Draft King or BeyondMe when they first started to trade, this would be a great indicator to use because the indicator doesn’t take a lot of time or data to print a signal. Instead of waiting on more trading data to start printing valid signals on other indicators, the Divergent Bar indicator can start giving you signals the very next day. So if you are on an hourly chart, after the first hour of trading, it could potentially print signals for you.

You can use the divergent bar on any type of bar. Personally, I use the standard bar. If you prefer the candlestick bar, it can work on that as well. If you use another indicator that prints on the bar, like the GRAB Candle or the 10x bars, then the divergent bar indicator might conflict with it and not print a proper signal. However, a great way to get around this is to create a grid chart. One chart can include the Grab Candles or 10x bars, while the other chart can hold the Divergent Bar Indicator. That way you can watch both signals, and have them both be valid and not cancel each other out.

Tip: If the divergent bar’s high (for a bullish divergent bar) and low (for a bearish divergent bar) is running right into a level of Resistance or Support and you’re looking for the underlying price to break that level in order for the signal to follow through, then it might have a harder chance of doing so. So if you take the signal, keep in mind to be cautious of it not having a strong follow through because the resistance (or support) might win the battle and not let the underlying price follow through all the way on the divergent bar signal. At other times, when the divergent bar matches with testing Support or Resistance, it can make for a stronger signal and potential move. That’s why I love bullish divergent bars off of support levels in bullish trends.

I like to call the Divergent Bar my Batman and the Compound Breakout Tool its Robin. Even though this indicator works great on its own, it can still help to have its sidekick to help solidify the signal and make for better entries . To learn more about the Compound Breakout Tool, visit… https://www.simplertrading.com/compound-breakout-tool/

Thanks to my trusty Divergent Bar Indicator, I’ve been able to better recognize when prices are moving up higher or down lower. If you’re interested in learning more about the Divergent Bar Indicator and how to add this indicator to your toolbox of strategies, visit https://www.simplertrading.com/divergent-bar-indicator

As always my fellow traders, may the trade be with you!