Bar-to-Bar Divergence Strategy: A New Approach
by: Dexter M. Garcia (code: %H&S Divergence)
An Overview of Divergence
Divergence serves as a vital tool in technical analysis, aiding traders in identifying and responding to shifts in price action. It occurs when a technical indicator or oscillator moves counter to the price trend or overall price movement. Divergence patterns often indicate potential price reversals, whether negative or positive. Negative divergence manifests when an asset's price climbs while the indicator descends or exhibits bearish signals. Conversely, positive divergence arises when the asset's price falls, yet the indicator ascends or shows bullish signals.
Conventionally, traders confirm divergence by connecting highs or lows on the price chart and corresponding points on the indicator, ensuring alignment. True divergence manifests when these connected lines exhibit clearly opposing slopes. Divergence signals hold greater significance in higher time frames but may prove less reliable in lower time frames. Moreover, once a divergence is identified and the price has already shifted significantly, the signal's validity may diminish.
Despite
its utility, implementing a divergence strategy can pose challenges. Divergence
signals may occasionally yield false alarms and may not manifest in all
instances of price reversals. Additionally, divergence patterns can persist for
extended periods before a price reversal occurs. Charting and interpreting
slope directions can also prove challenging, with each trader applying
subjective methods prone to errors, potentially leading to inaccurate trade
decisions.
The
Bar-to-Bar Divergence Strategy introduces an innovative approach to detecting
and recognizing divergences, aiming to address challenges commonly encountered
in traditional divergence trading methods. By striving to minimize subjectivity
and charting errors, this strategy offers a more objective means of analysis.
While firmly grounded in divergence theory, it diverges from conventional
techniques by connecting the closing prices of candles with their corresponding
RSI values to identify divergence patterns.
Figure
1. Bar-to-Bar Bearish Divergence
Conversely, to identify a bullish divergence, pinpoint the "red anchor," representing a red candle with the lowest RSI value over the designated period. Connect the closing price of the red anchor to the closing price of the subsequent red reference candle, while ensuring alignment with the RSI slope of the red candles in question. Like bearish divergence, both the anchor and reference red candles must be followed by a green candle to validate the bullish divergence pattern.
Figure 2.
Bar-to-Bar Bullish Divergence
It is
important to use other indicators to confirm the signal such as support and
resistance levels, pivot points or price action patterns.
This Pine script is designed to pinpoint bar-to-bar divergence and candle price action within specified start and end dates, where the start date denotes the anchor candle, and the end date represents the reference candle.
The script commences by establishing an input parameter for the RSI calculation length, with a default setting of period 3. Users can adjust the start and end dates to their preferred candle date and time, with date markers appearing on the chart for manual adjustments.
By analyzing the price action and RSI values of candles on the selected dates, the script determines whether a short or long entry should be made. This evaluation is based on a comparison of the closing prices and RSI values between the start and end candles, with the objective of identifying market sentiment divergences.
// This Pine Script™ code is
subject to the terms of the Mozilla Public License 2.0 at
https://mozilla.org/MPL/2.0/
// © DexterMGarcia
//@version=5
strategy("Microdivergence ver4", overlay=true)
// Input parameters
rsi_length = input.int(3, "RSI Length", minval=1)
// Calculate RSI
rsi = ta.rsi(close, rsi_length)
// Define the specific start and
end dates for the markers
startDate = input.time(defval=timestamp("31 Jan 2022 02:20
+0000"), title="Start Date")
endDate = input.time(defval=timestamp("31 Jan 2022 02:20
+0000"), title="End Date")
// Find the index of the candle
corresponding to the start date
startIndex = ta.barssince(time == startDate)
// Find the index of the candle
corresponding to the end date
endIndex = ta.barssince(time == endDate)
// Plot a dot marker at the
specific start date with yellow color
plotshape(startIndex >= 0, style=shape.circle, location=location.abovebar, color=color.yellow, size=size.small, title="Start Marker")
// Plot a dot marker at the
specific end date with red color
plotshape(endIndex >= 0, style=shape.circle, location=location.abovebar, color=color.red, size=size.small, title="End Marker")
// Check conditions for green
candles
if (startIndex >= 0 and endIndex >= 0)
// Check if both candles at
start and end dates are bullish
if (close[startIndex] > open[startIndex] and close[endIndex] > open[endIndex])
// Condition 1: if closing price
of candle at start date is higher than closing price of candle at end date but
RSI value of start date is lower than RSI value of end date, then generate a
short signal
if (close[startIndex] > close[endIndex] and rsi[startIndex] < rsi[endIndex])
strategy.entry("Short", strategy.short)
// Condition 2: if closing price
of candle at start date is lower than closing price of candle at end date but
RSI value of start date is higher than RSI value of end date, then generate a
short signal
else if (close[startIndex] < close[endIndex] and rsi[startIndex] > rsi[endIndex])
strategy.entry("Short", strategy.short)
// Condition 3: if closing price
and RSI value of candle at end date are both lower than closing price and RSI
value of candle at start date, then generate a short signal
else if (close[endIndex] < close[startIndex] and rsi[endIndex] < rsi[startIndex])
strategy.entry("Short", strategy.short)
// Condition 4: if closing price
and RSI value of candle at end date are both higher than closing price and RSI
value of candle at start date, then generate a long signal
else if (close[endIndex] > close[startIndex] and rsi[endIndex] > rsi[startIndex])
strategy.entry("Long", strategy.long)
// Check if both candles at
start and end dates are bearish
else if (close[startIndex] < open[startIndex] and close[endIndex] < open[endIndex])
// Condition 1: if closing price
of red candle at start date is higher than closing price of red candle at end
date but RSI value of start date is lower than end date then generate a long
signal
if (close[startIndex] > close[endIndex] and rsi[startIndex] < rsi[endIndex])
strategy.entry("Long", strategy.long)
// Condition 2: if closing price
of red candle at start date is lower than closing price of red candle at end
date but RSI value at start date is higher than RSI at end date then generate a
long signal
else if (close[startIndex] < close[endIndex] and rsi[startIndex] > rsi[endIndex])
strategy.entry("Long", strategy.long)
// Condition 3: if both closing
price of red candle and RSI value at start date are lower than closing price of
red candle and RSI value at end date then generate long signal
else if (close[startIndex] < close[endIndex] and rsi[startIndex] < rsi[endIndex])
strategy.entry("Long", strategy.long)
// Condition 4: if both closing
price of red candle and RSI value at start date are higher than closing price
of red candle and RSI value at end date then generate short signal
else if (close[startIndex] > close[endIndex] and rsi[startIndex] > rsi[endIndex])
strategy.entry("Short", strategy.short)
References:
What is Divergence in Trading? | Definition & Examples | Finbold
Trading Strategy: How to trade divergence with technical indicators (flowbank.com)
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