Divergence FX Engine

One of the core principles in technical analysis is divergence, a situation in which the price is moving in the opposite direction of a trend indicator such as the moving average. Of the various definitions I've read of divergence, I found Investopedia's the most straightforward.

Here's an example of one divergence you're likely to see: during an uptrend, the price is hitting higher highs, but the moving average has begun to slow its ascent and may even be trending downward. In this case you're seeing the last gasps of that trend, as the price attempts to move up but finds less and less support. At the same time you're likely to see larger and larger gaps between the high prices and closing prices, with the lower closing prices contributing to that downward shift in the moving average.

One handy, albeit cartoonish, way to visualize this kind of divergence is picturing a guy in a rollercoaster who's forgotten to strap himself in. As the rollercoaster roars up an incline and reaches the top, the upward momentum tosses the guy up into the air, where he continues upward for several feet as the rollercoaster levels off and then begins to shoot downward again. And you know the rest...after hanging there in midair for a moment, he plummets back down, hopefully into his seat or else some understanding person's lap.

The same divergence rules apply in a downtrend, for instance when the price hits new lows while the moving average begins to level off and then move upwards. (It's harder to create a rollercoaster analogy for this one, though...maybe picture the guy hanging from a bungee cord underneath the rollercoaster? In any case, he's not going to be in good shape after this particular ride - hopefully your divergence trades will end more happily :-)

But getting back to the title of this post, I decided to try and create a divergence-based engine in FX Engines. I played around with a few different breakout and moving average signals and was able to come up with a profitable engine for trading the GBP/USD pair pretty quickly. Over 3 years of backtesting it turned a profit of 3,294 pips. Here's the formula:

Currency Pair: GBP/USD
Trade Direction: Long
Entry Signals:
(1) FXE EMA 20 LONG 60 MIN TREND - this is one of the installed sample engines that comes free with an FX Engines account.

(2) 60 Minute Short Breakout Signal - this one you'll have to make yourself in the Breakout Signals section of the site. Here are the parameters:

Signal interval: 60 minutes
Signal type: Entry signal
Signal activates: Price breakout below the previous period's close minus 15 pips

As you can see, you now have a long moving average trend paired with a short breakout signal: two signals diverging in opposite directions.

Entry Type: Market entry

Entry Schedule: Activate my entry signals only during London-New York trading (2 AM EST to 4 PM EST Monday-Friday)

Exit Strategy: Scroll down to Option 4: Contextual Exits and choose this pre-installed exit signal: 1 LEVEL 60 MIN P/100 EXIT SIGNAL

(This is one of the best all-around exit signals in FX Engines.)

Now just hit "Finish" and you're done. Happy divergence trading!

Related links:
FX Engines
Divergence Definition

Related topic:
My Best GBP/USD FX Engine