Convergence/Divergence to Determine the Best Trade

From time to time, the market will reach an inflection point where it may move in one direction or another. These inflection points can represent not only a favorable risk to reward scenario, but also an indication where the market might propel itself quickly to new price levels. These critical points on the charts often already take the form of a double top/bottom pattern. A double (and sometimes triple) top/bottom occurs when the market visits the same price level at least 2-times, where about half the traders believe the market will follow through to new highs, and the other half of the collective market anticipates a reversal back in the opposite direction. So the question remains, what can we do to increase our chances of being correct?



The MACD (Moving Average Convergence/Divergence) indicator can help give us some guidance. This commonly used tool shows us the relationship between two moving averages and gauges the internal strength or weakness of the current trend. Upon forming a double top pattern, we may logically anticipate the MACD to follow suit and register a similar high level. With this in mind, if the MACD converges or accomplishes this high price, we may anticipate the market to follow through and soon trade to new high prices. On the other hand, if the MACD diverges, or fails to accomplish a similar high level, we may anticipate that the likelihood of a reversal may be far more likely. Simply put, (1) we should wait for the market to test the same price level at least twice, (2) reference the MACD to gauge the internal strength or weakness, and then (3) execute the trade accordingly.

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